The investment opportunities today are not bound by geography. When investing in a foreign stock, knowledge about the political and economic conditions of the country is a must as it can have a huge impact on the returns. In this article we will cover different types of investment options available if you’d like to invest in foreign stocks. Please note that this discussion is general and does not apply to investors from an individual country.
Types of foreign investing
American Depository Receipts (ADRs)
An American depositary receipt (ADR) is a negotiable certificate issued by a U.S. depository bank representing a specified number of shares (often one share) of a foreign company’s stock. The ADR trades on U.S. stock markets as any domestic shares would. ADRs offer U.S. investors a way to purchase stock in overseas companies that would not be available otherwise.
Companies abroad use ADRs to establish a presence in U.S. markets and sometimes raise capital. For example, Chinese e-commerce giant Alibaba raised $25 billion in 2014 and listed its ADRs on the New York Stock Exchange (NYSE)
ADRs have three levels.
Level 1 – ADRs are used to establish a trading presence in the U.S., but cannot be used to raise capital.
Level 2 – ADRs are used to create a trading presence on a national exchange such as the NYSE. However, these can’t be used to raise capital.
Level 3 – ADRs can be listed on national exchanges as well as to raise capital.
Global Depositary Receipt (GDR)
A GDR is very similar to an ADR. It is a type of bank certificate that represents shares in a foreign company. The shares themselves trade as domestic shares, but, globally, various bank branches offer the shares for sale. Private markets use GDRs to raise capital denominated in either U.S. dollars or euros. When private markets attempt to obtain euros instead of U.S. dollars, GDRs are referred to as EDRs.
GDRs can be found on the London Stock Exchange and Luxembourg Stock Exchange. These can be found on exchanges in Singapore, Frankfurt, and Dubai as well. GDRs are typically placed with institutional investors in private offerings before public trading.
Foreign Direct Investing
An Investor can buy stocks directly using either or both of the following two ways. Either the investor can open a global account with a broker in its home country or open an account with a local broker in the target country.
Foreign Direct Investing is more suitable for investors who are active and serious. It is because there are additional costs, tax implications, technical support needs, research needs, currency conversions, and other factors to consider.
When trading foreign stocks directly, use brokers that are registered with regulators in their market such as the Securities and Exchange Commission (SEC) in the U.S.
Global Mutual Funds
A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other securities. Investors who wish to participate in global markets but don’t want much hassle should opt for a mutual fund that focuses on international equities.
International mutual funds come in variations, from aggressive to conservative. They can be region or country-specific. They can be an actively managed fund or a passive index fund tracking an overseas stock index. However, globally focused mutual funds can have higher costs and fees than their domestic counterparts.
Exchange-Traded Funds (ETFs)
An Index Fund is a fund designed to follow certain preset rules so that the fund can track a specified basket of underlying investments.
Exchange Traded Funds are essentially Index Funds that are listed and traded on exchanges like stocks. Rather than, constructing a portfolio of stocks yourself, picking the right ETF is simpler.
Certain ETFs provide exposure to multiple markets, while others focus on a single country only. These funds cover a number of investment categories such as market capitalization, geographical region, investment styles, and sectors.
Prior to buying a global ETF, investors should consider essential factors such as costs and fees, liquidity, trading volumes, tax issues, and portfolio holdings.
Multinational Corporations (MNCs)
If you are an investor who is not comfortable with buying foreign stocks directly, and is wary of ADRs or mutual funds then, you should opt for domestic companies that derive a significant portion of sales from overseas.
Multinational corporations (MNCs) are best suited for this purpose. For example, buy a portion of The Coca-Cola Company (KO) or McDonald’s (MCD). Both of the companies generate the majority of their revenue from global operations.
The Flip Side of International Investing
Financial Advisors recommend a 5% to 10% allocation for conservative investors, and up to 25% for aggressive investors. This is to ensure that conservative don’t end up losing a significant chunk of their life savings by making equity investments which in turn can turn out to be risky.
Emerging markets are generally considered risky. They can experience dramatic changes in market value, and in some cases, political risk can suddenly upend a nation’s economy. Furthermore, it should be noted that foreign markets can be less regulated than those in the U.S., increasing the risk of manipulation or fraud. In addition, speculation and subjectiveness makes investments in emerging markets even riskier.
Despite 24-hour global news access, there is always a certain risk of inadequate information of the foreign market. This can limit an investor from analyzing certain events.
At last, there is a currency risk pertaining to changes in the exchange rate against the investor’s home currency.