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According to the Securities and Exchange Commission, international investing continues to be a popular, and expanding, area for American investors. As early as 1985, the total capitalization, or market value, of foreign stocks surpassed the value of U.S. stocks for the first time. Add to this the tripling of the number of foreign companies that have registered with the SEC over the last 15 years, and we see an interesting trend emerging.
Americans have a growing interest in foreign companies; and the fact that so many foreign companies are registering with the U.S. Securities and Exchange Commission means these companies are also interested in American investors. But why the sudden interest in international investing over the last 15 years?
Advantages of International Investing
There are two main reasons that investors in America have been flocking to international companies: growth and diversification.
Growth of International Companies
There is no doubt that the American economy is experiencing a period of slow growth. In late 2007, it was announced that over the past year the U.S. gross domestic product, or GDP, grew at 3.7%. Growth in productivity, however, was only 2.5%, which is the result of even slower growth in output per hour.
Compare the U.S. GDP figures to China and Pakistan, which are experiencing growth rates of 9.5% and 8.4% respectively. This data tells us the real economic growth opportunity exists overseas.
Diversifying with International Companies
The other advantage international investing has to offer investors is diversification. By spreading money across both international and domestic companies, there is more opportunity to lower the overall risk of the investment portfolio. For example, if the U.S. economy starts to falter, then the investor has a chance to leverage growth in a foreign economy. This allows the investor to maximize the returns of their stock portfolio.
Risks of International Investing
Let's face it; the stock market is a risky place to invest. That's why the potential rewards are high. But international investing carries with it another set of risks that investors should be aware of. In fact, many of these risks are quite significant, and can make international investing problematic for many Americans.
International Currency Rates
When you invest in an international company, you are also assuming a risk associated with international currency rates. For example, when you purchase stock in an international company, the U.S dollar needs to be exchanged for the foreign currency. When you eventually sell the stock, that foreign currency needs to be converted back into American dollars.
During the time when you hold this international investment, the exchange rate of U.S dollars and the foreign currency can shift. This shifting can have an impact on the return on your investment.
Let's say you're investing in a company that has experienced strong growth, and the currency of that country is strong compared to the United States. When this happens, you benefit from both the company's growth as well as the exchange rate. Of course the opposite can also occur, either offsetting a potential gain or adding to a loss.
International Politics
While some individuals complain about the policies of the U.S. government, there is no doubt the government itself is stable. The same cannot be said for many of the emerging international economies. When investing in foreign companies, there are very real risks of government destabilization and the consequent negative impacts on the foreign corporations in that country.
Operations of International Stock Markets
The final comment on the risk of international investing has to do with the operation of foreign stock markets themselves. Foreign companies that are not registered with the U.S. Securities and Exchange Commission may not report financial information on a frequent basis, often leaving investors wondering what is happening with the company itself.
There may also be different rules for the clearance and settlement of stock trades. The confirmation of trades, and the reporting of the transaction, may be much slower than in American markets. Finally, shares are often held safe with custodian banks and depositories. If this holding bank runs into financial difficulties, shares of stock held by that institution may not be protected.
Ways to Invest Internationally
Now that we've explained the benefits and the downside of international investing, were going to explain how to participate in these foreign markets. In this publication, we're going to talk about the three most common ways: mutual funds, American Depository Receipts, and stocks traded on foreign markets.
International Mutual Funds
Perhaps the easiest way to invest internationally is to purchase mutual funds. In fact, you will have a choice of several types of foreign mutual funds. Each fund type will offer the investor a slightly different opportunity to play in the international market. Such groups of international funds include:
- International Index Funds - like their counterparts domestically, these funds attempt to mimic the returns of international stock exchanges.
- International Funds - funds of companies located outside of the United States.
- Regional Funds - mutual funds that invest in companies located within a specific geographic region such as South America or a specific country.
- Global Funds - mutual funds of this type offer the opportunity to invest money on a global or worldwide basis, including foreign and domestic companies.
American Depository Receipts
Most of the international stocks traded in the United States are traded as American Depository Receipts, or ADRs. These stocks are issued by U.S. depository banks. Owning an ADR means the investor is entitled to hold the number of shares listed on the ADR. Many U.S. investors find it more convenient to hold the ADR instead of directly holding foreign shares of stock.
One advantage of holding an ADR is that the trade clears and settles in U.S dollars. The depository bank will convert stock dividends for you, and may also arrange for voting. The downside of owning an ADR is that the depository bank acts like a middleman. This adds to the time it takes for a transaction to occur as well as additional cost in the form of depository fees.
Stocks Traded on Foreign Markets
If the international company only trades on a foreign market, then you may need the help of a stock broker to process the transaction. Make sure the broker you're using is registered with the SEC. As previously mentioned, stocks traded on foreign markets may not report information in the standardized format the SEC demands. That means any stock research you conduct to make your investment decision may be limited in terms of information that is freely available and accurate.
About the Author - International Investing Opportunities
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