The Investment Series: International Investing Basics

International Investing Basics  (Go to the Investment Series for other Basics)

This is the fifth article in a series on investment basics. If you are new to investing, it is recommended that the articles be read in order. Prior articles introduce terminology that is used in later articles.

A Multiple Choice Question
International Risk
Too Risky, Too Foreign, Too Weird
Ways to Invest Internationally
Parting Thoughts
A Five Year Snapshot

 

A Multiple Choice Question:

Between 1970 and 2000, how many times has the U.S. equity market been the world's top performer?

(a) Never
(b) Once
(c) Several times
(d) Every time

Answer: (a) NEVER. Not only that, the US equity markets have ranked among the top 3 only twice in the last 10 years.

Surprised? International Investing is not just for high-flying risk takers. It can form part of the asset allocation of a well rounded portfolio. It can improve portfolio gain due to participation in well performing markets. It can reduce portfolio risk by improved diversification since international markets often behave differently than the U.S. markets.

 A five year snapshot below shows the two times in the last 10 years that the U.S. markets have at least made it into the top three.


International Risk

International Investing involves three areas of additional risk when compared to domestic (U.S.) investing: political risk, currency risk, and market risk.

Political risk addresses the stability of the government, the actions of the government, and the stability of the political climate. Governments can change, governments can take over companies, and governments can drastically change policies and rules.

Currency risk is concerned with the value of the stocks local currency as compared to the U.S. dollar. This concern includes not only day to day fluctuations in exchange rates, but also longer term trends such as inflation.

Market risk addresses the reliability of reported corporate information and the ease (or lack thereof) of trading shares. Corporate reporting by U.S. companies is rigorously legislated. The same degree of rigor is not seen in many international markets, making the information less reliable. Furthermore, accounting practices may differ making comparisons to U.S. corporations difficult even if the reporting is  reliable. For example, long term debt versus total capital is a ratio used by analysts. In the U.K., an accounting rule about goodwill amortization can cause the capital valuation to appear low, thereby leading to potentially incorrect comparisons.

These risks can work both ways. They may act to hurt the investor; or they may act ot help the investor.

Too Risky, Too Foreign, Too Weird

Here's a true false quiz:

1. The world's largest food company is, of course, a U.S. company.

2. Burger King, Breyers Ice Cream, Dunkin Donuts, and Dannon Yogurt are all U.S. companies.

3. Since the U.S. is a world leader in technology, clearly the leading mobile phone operator in the world will be a U.S. company.


How did you do? ALL are FALSE.

1. The world's largest food company is Nestle SA and is based in Switzerland. (January 2000)

2. None are US companies. Here's the breakdown.

  Item Company Country  
  Breyers Ice Cream Unilver NV Netherlands  
  Burger King Diageo U.K.  
  Dunkin Donuts Allied Domecq U.K.  
  Dannon Yogurt Dannone Group France  

3. The leading mobile phone operator in the world is Vodaphone Airtouch Plc based in the U.K. (January 2000)

Ways to Invest Internationally

For the U.S. based investor, buying and selling directly on international markets is fraught with difficulties. So the marketplace has developed a number of options to make it easier. Here are some of them

Mutual Funds
As discussed in "Mutual Fund Basics", the prospectus is extremely important as it defines the boundaries within which the fund manager must operate. A fund called an international fund may be quite limited in its scope.

ADR's (American Depositry Receipts)
An ADR is a registered security issued by a U.S. bank representing shares of a foreign stock. ADR's trade on U.S. stock exchanges and on the OTC (Over the Counter) market. Companies traded through ADR's comply with U.S. General Accounting Practices.

IShares (formerly WEBS)
Once known as WEBS (World Equity Benchmark Shares), IShares are index funds that trade like stocks. IShares are available for both U.S. and international equity indexes. There is a key difference between IShares and mutual fund index funds. Mutual fund trades are generally executed at NAV (Net Asset Value) at the end of the day following market close. IShares trade throughout the day whenever the market is open. Even stop and limit orders can be place against IShares.

Parting Thoughts

Due to the additional risk of international investing, it should be clear that high quality research is a must in making sound international investment decisions. Last year's best performing market will likely not be the best performer of the following year. Comprehensive, forward looking research is necessary to invest wisely in international markets.

Check back for the next installment in the Investor Series: Basic Investment Strategies.

 

The Five Year Snapshot

Year First Second  Third
1991 HONG KONG
49.5%
AUSTRALIA
33.6%
USA
30.1%
1992 HONG KONG
27.4%
SWITZERLAND
15.6%
SINGAPORE/MALAYSIA
4.4%
1993 HONG KONG
109.9%
MALAYSIA
107.3%
FINLAND
81.3%
1994 FINLAND
52.2%
NORWAY
23.6%
JAPAN
21.4%
1995 SWITZERLAND
44.1%
USA
33.4%
SWEDEN
33.4%
Source:  Morgan Stanley Capital International. Percentages rounded to tenths. Past performance does not guarantee future results.

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