Investing in foreign stocks means holding shares of companies that are not only based in different geographical locations but also driven by the respective economy-specific factors. Investing in foreign stocks helps to spread the investment risk among the international markets that are different from the home economies.
People who choose to invest in international markets look to gain from the diversification and growth in other economies. This is an important factor since no particular market has consistently remained on the top, and there are a wide range of high-performance markets all over the world.
But note that, just like most other things, International investing has its flip side. When measured in terms of Volatility, foreign stocks are considered to be more risky. Besides, the risk of dramatic changes in their market value, international stocks also have other risks associated with them e.g. Currency Risk which stems from potential unfavorable movements against the home currency. But at times currency movement can also work in favor of the investor and help in enhancing his/her returns. Political Risk that arises from an unstable government or military action in the country of investment. We also have a Inadequate Regulation Risk in the global markets as compared to developed markets like those in the United States. This increases the risk of manipulation or fraud. Another Risk is Insufficient Information available about various international markets, which can limit the investor’s precision of market movements. You can have difficulties interpreting the international market’s information as an outsider investor in addition you need to take note of the fees involved like the commissions and Taxes.
The are various Routes that one can trade foreign stocks as discussed below:
- Direct Investing – There are two ways by which investors can invest directly in foreign stocks. The first way is by opening a global account with a broker in their home country, providing the ability to buy foreign stocks like E*TRADE, Charles Schwab, Fidelity etc. in the United States. The second way is to open an account with a local broker in the target country that offers services to international investors like OCBC Securities in Singapore , Boom’s Trading Platform in the Hong Kong. These two trading Platforms gives access not only to local market but other stock markets. Investors should make sure that these brokers are registered with the market regulator in the home country. In order for investors to pick the right trading platform based on their investing style and interest, they need consider other factors like fees, costs, and facilities provided by the brokerage firm. It is not advisable for small investors to go direct as the system is complicated involving so many things like currency conversions, costs, taxation issues, technical support, research etc. Only serious and established investors should indulge in this process.
- American Depository Receipt (ADR) – ADRs work well for investors as well as for non-US companies. ADRs offer investors a convenient way to hold foreign stocks and also provide an opportunity to non-US companies to establish an US presence and even raise capital in the US stock Markets. Example is one of Alibaba Group Holding Limited World’s largest IPO. The ADRs can be either sponsored or not and have 3 different levels depending upon foreign companies’ access to US markets, as well as disclosure and compliance requirements. Level 1 ADRs cannot be used to raise capital and are only traded over the counter while level 2 and level 3 ADRs are both listed on an established stock exchange e.g. NYSE, NASDAQ only Level 3 ADRs can be used to raise capital.
- Global Depository Receipts (GDRs) – With GDRs a depository bank issues shares of foreign companies in international markets typically in Europe and are available to investors within the US giving them an opportunity to invest in foreign stocks. Though they GDRs are dominated in US dollars and at times in Euros or Sterling Pound, they are typically traded, cleared, and settled in the same way as domestic stocks. London and Luxembourg stock exchanges are the most common destination for listing of GDRs other exchanges include those in Singapore, Frankfurt and Dubai.
- Mutual Funds – These funds are like regular mutual funds in terms of the benefits they offer and how they work. except they hold a portfolio of foreign stocks rather than domestic stocks. These funds come in a variety of flavors with something for everyone from aggressive to conservative investors. The main types of funds that invest in foreign funds are Global Funds, International Funds, Region or country specific funds and international Index Funds. But note that just like many other international investments, these funds tend to be costlier than domestic counterparts.
- Exchange-Traded Funds (ETFs) – Picking the right ETFs is easier for investors than constructing a portfolio of stocks by themselves. While a single ETF can offer a way to invest globally, there are ETFs that offer more concentrated picks e.g. on a particular country. There are a wide range of international ETFs within different categories like Geographical Region, Market capitalization, Investment style, sectors etc. Some of the ETFs come from Providers like Schwab, Flexshares, iShares, SPDR, Vanguard etc. Investors should research the costs involved, liquidity, fees, trading volume, taxation and portfolio before buying any international ETFs.
- Multinational Corporations – If you are not comfortable investing in international stock using the above methods, then you can look for domestic companies that have a majority of their sales and revenue overseas. For an US investor Coca-cola company(KO) or the McDonald’s Corporation (MCD) provide a good example.
There are many routes to choose from if you want to invest in foreign stocks but it is paramount that the investor first learn about the product they are investing in before they make an informed decision which one he/she can pick besides having knowledge about the political and economic conditions in the country of investment which is essential to understanding the factors that could affect the investment returns. Investors should put focus on their investment objectives, costs and prospective returns, balancing it with their risk tolerance when they are making a choice on international foreign stocks.