Does My Money Need A Passport? (2)

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It has been reported that 54% of investment opportunities in the world, based on capitalization, are located in countries other than the US.  Of the ten largest car manufacturers in the world, only three of them are American.  Similarly, seven of the ten largest companies engaged in telecommunications are in other countries.  Half of the ten largest household products manufacturers are located outside the US, but their products are available here.  The vast majority of mining operations are found overseas.

If an individual investor has decided that a portion of his or her portfolio should be invested in foreign stocks, there are several alternatives available.  International investing can be accomplished with mutual funds, exchange traded funds (ETFs), direct investing in a foreign market and American Depository Receipts (ADRs).  The costs, expenses and difficulties of directly buying a stock in a foreign market put this strategy out of the reach of most individuals.

Mutual funds and ETFs come in two varieties.  A "Global Fund" invests in companies throughout the world.  This means that a portion of the fund will hold stocks in the investor's own country.  If the fund is labeled "International" or "Foreign", there will be no stocks from the investor's country in the portfolio.   

Some mutual funds and ETFs invest only in developed countries, such as England, France, Japan and Germany.  Others focus on emerging markets, less developed countries with prospects for increased rates of growth.  In 2003, the investment firm Goldman Sachs identified Brazil, Russia, India and China as the four emerging markets with the greatest potential to become dominant in the global economy.  The countries are collectively referred to by the acronym BRIC.  Goldman projected that China and India would together lead the world in manufacturing.  Russia and Brazil would become leading suppliers of raw materials. These countries are, obviously, not a political bloc.  However, if they worked together financially, they could become a very powerful economic force in the global economy by 2050.  BRIC could surpass today's economic powers, including the US.

The investment firm JP Morgan introduced ADRs to American investors in 1927.  This was one of the first ways to invest internationally in this country.  An investment firm purchases and holds large amounts of foreign stocks in safekeeping.  It then sells shares or receipts in that portfolio (just like a mutual fund) to US investors.  Those receipts are traded on Wall Street in US dollars, just like US stocks.  These days, some foreign companies cut out the middle man, the investment firm sponsoring the ADRs, and issue their shares directly into the US markets.

International investing brings added risks.  Since foreign companies are not necessarily subject to the disclosure requirements imposed on US companies by the Securities & Exchange Commission, financial information can be difficult to get and may not be entirely reliable.  Political instability in emerging countries could detrimentally affect companies in those countries.  There are many examples of companies being nationalized by foreign governments.  Currency exchange rates fluctuate daily, which can impact the US dollar value of an investment.  Inflation rates vary from country to country and could drive down the value of a foreign stock held by an American investor even though the actual business of the company has not changed.

One last thing to keep in mind.  US companies are increasingly becoming global in their own right.  Approximately half of the companies on the S&P 500 Index break out global sales in their financial reports.  Global revenues of the reporting companies represented 46% of their total revenues.  Therefore, almost 25% of all S&P 500 revenues came from foreign countries.  If you assume that the same percentages hold true for the companies which do not break out their foreign business, it could be that almost 50% of the revenue of the S&P 500 companies is international.  If this is the case, an individual investor might safely invest "internationally" by simply buying an S&P 500 Index mutual fund or ETF.

Comments are always welcome.