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William J. Lynott How to Invest in Foreign Stocks A PHOTO: CORBIS
lot of attention is being paid these days to the global economy and its influence on the American mar- ket, and with good reason. While many people continue to think the world market consists of third- world countries wallowing in the financial doldrums, there are im- portant exceptions that have grabbed the attention of Ameri- can investors.
While our own economy has struggled since the 2008 melt- down, other countries have pros- pered. The US economy grew at a rate of about 3 percent in 2010 while the economies of some de- veloping economies such as Bra- zil, India, and China grew at twice that rate or more. These higher growth rates have generated attractive opportunities for those investors who have managed to free themselves from the notion that the US economy is the only sensible repository for their hard- earned cash. That said, global stocks come with all of the same risks as do- mestic equities, plus a few of their own. Political unrest is a potential problem that can have a devastating effect on the econo- mies in many countries. Out-of- control inflation or currency de- valuation is, or can be, a problem in some emerging markets. Fi- nally, especially for those invest- ing in individual stocks, the diffi- culty
of 8 properly researching
companies you plan to invest in is magnified by significant differ- ences in culture and language. It’s hard enough to tell hype from substance when you share the same language and basic as- sumptions with the people who run the company. For these reasons, I feel that
foreign investments should be no more than 10 percent of your portfolio, and less than that if you are of a conservative bent. For- tunately, there are a number of options for getting into foreign investing without getting in over your head.
The Shallow End: Global Mutual Funds
If you decide to dip a toe in foreign investment waters, where should you start? The simplest approach is to invest in a global mutual fund or exchange-traded fund (ETF) offered by an Ameri-
The simplest approach is to invest in a global mutual fund or exchange-traded fund (ETF) offered by an American company.
can company. The major fund families offer a number of op- tions, including funds that invest primarily in foreign companies but also buy shares in US compa- nies and regional and country funds that limit their investments to particular geographic areas, such as Asia or Europe, or to individual countries, such as Bra- zil
or Russia. Most American companies also offer foreign in- dex funds which simply track in- ternational indexes in the same way as US index funds track US indexes.
Investing in these funds offers the advantage of simplicity and the comfort of knowing your money is in the hands of profes- sionals. But for those who prefer a more hands-on approach, or who want to avoid the price tag that comes with professional help, there are other options available for investing overseas.
American Depositary Receipts
To help those investors who wish to invest directly in individual companies overseas, US banks created a system of American Depositary Receipts (ADRs). To create an ADR, a US bank buys a large block of stock in a foreign company, usually with that company’s cooperation, and bundles the shares for reissue on American stock exchanges. The ADRs trade in US dollars on American stock exchanges just as US stocks do, so individual investors don’t have to bother with currency conversions to buy or sell them.
However, even though the ADR shares are priced in dollars, investors are still exposed to ex- change-rate risks. The price of an ADR normally follows the price of shares of the stocks on its home country exchange, and if the value of the home country’s currency plummets, so will the price of the ADR stock. Though the US price and the price on the native exchange will sometimes differ a bit, these differences do tend not to last very long. The first ADR was introduced by JP Morgan more than eighty years ago for the British retailer Selfridges & Co. Today, there are four major commercial banks that provide depositary bank ser- vices: JP Morgan, Citibank, (Continued on page 56)
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