Investing globally has garnered a great deal of attention recently. It's on the minds of clients, advisors and the manufacturers of everything from exchange-traded funds to separate accounts.
And just as individual investors' long-term record of performance is nowhere near the index averages, investing globally can easily become a buy-high-and-sell-low debacle in your clients' portfolios if not done well.
Let's go over a few basics. When you hear the term international investing being used, that refers to investments that are devoid of any U.S. holdings. When the term global investing is used, that may include foreign holdings or holdings based in the U.S.
The next question is that of sizing the opportunity. From all of the reports that I've seen in the last few years, it appears that certain foreign markets, specifically the emerging markets, have larger growth prospects than the U.S. over the next few decades. That makes a lot of sense to me. Add the attraction of modern-day comforts to economies that have a higher savings rate than the U.S. and you can almost see the buying frenzy that may erupt as these comforts become ubiquitous. This alone, however, does not make a terrific profit opportunity for investors.
INHERENT RISKS
There are risks that come with investing globally that are very unlike those we deal with here in the U.S. The risks are currency, political instability, liquidity, transparency and inflation. Each one of these risks is fairly material in its own right, but if you get a few of them working in harmony against you, your investment can get crushed.
Currency risk is a lot deeper than most investors understand. Naturally, it's a concern if the value of any currency fluctuates wildly when you are invested in assets of that nation. But when invested in foreign assets whose local currency takes
a nosedive, it's not necessarily bad for you because it is possible that the U.S. currency takes an even bigger nosedive. It is also possible to own foreign investments that are denominated in the local currency or U.S. currency. That is a decision that is frequently over the head of most investment advisors, and only well understood by financial analysts with significant experience in foreign investing. Perhaps this is only the first of many reasons why CPA advisors are well advised not to rely on the popular press and fake it as a portfolio manager. The wise advisor will seek specialized help.
Political instability seems to be the way of many foreign nations - especially when you get into the less-developed nations around the world. Head east to Africa, the Middle East or parts of the Far East, and it seems like the norm. Can you even remember a week in which there wasn't news about rigged elections, dictators and assassination plots in some remote spot on the globe? It seems rather obvious, but it may not be good for your portfolio to be invested in countries where people are killing each other over a bottle of water.
REMAINING LIQUID OVERSEAS
Liquidity is also an issue, and from several perspectives. First, world stock markets are not always open for what we may consider normal trading hours. In the U.S., markets are traded five days a week for 6.5 hours per day. But the Karachi Stock Exchange is only open for 4.5 hours per day. The Egyptian Stock Exchange is only open for four hours per day. (Egypt is a great example, as we have seen nearly every risk known to foreign investors in the month of February alone.) Most foreign country stocks can be purchased through U.S. firms that have relationships with traders on the floor of these foreign exchanges, but that puts yet another middleman in the way of your assets going to work for you, and yet another layer of fees.
Liquidity again comes into play when you want to trade in something that is thinly traded. Without adequate trading volume, pricing - and therefore the value of your holding - is suspect. Exactly what is your investment worth if there have only been a few trades over the past month in that position? You may not really know until you try to sell.
TRANSPARENCY AND INFLATION
Transparency in the U.S. has gone from a buzzword a few years ago to the way we do business in the financial world. Other countries, however, have not declared transparency as their way of doing business. Not only is transparency important with respect to costs, but it is an issue with financial reporting, insider trading, management experience, mergers and acquisitions, trade secrets, and corporate business plans in general. Seasoned foreign investors spend millions in additional diligence to enhance their decision-making ability.
Inflation is a risk everywhere - but it's also measured differently everywhere. Which measure is better is a subject debated all over the world by economists; the important point to understand is that inflation rates published by different countries cannot be compared simply. Beyond developed nations, double-digit or triple-digit inflation happens every year somewhere in the world, and it can change fast. You do not want to get washed away in another country's tsunami of inflation.
SUMMARY
Hopefully, these risks haven't overshadowed the opportunities available by investing globally. And if you're still game, the only questions left are what countries, what asset classes and how much.
When I started as an investment advisor in the 1980s, it was common to hear investment consultants speak in terms of a 5-percent-to-10-percent position in foreign equities. Foreign holdings were viewed as non-correlating assets. Today, it appears to be a bit more correlated than it was 30 years ago, and many economists have stated a case for holding as much as 40 percent of one's portfolio in foreign investments. Some economists, perhaps a bit more extreme or radical, have made even bolder predictions and suggest a majority of your portfolio in foreign investments.
As significant as the rise in materiality that foreign assets occupy in portfolios today are the asset classes represented. We have gone way beyond foreign equities only, and today investors are gobbling up foreign fixed-income, real estate and equity. And while I cannot say that this is the best time to buy deeply discounted fixed-income positions in countries like Spain, Ireland or Greece, I will say that these issues have been massacred in the public markets and that the time to acquire them may be upon us sooner than you might imagine.
Before you use this article or any other general research about foreign investing, make sure that you consult with a specialist. I, for example, am very impressed by the gross domestic product numbers and the potential growth that seem imminent for many emerging markets. It seems like everyone else believes this story too, and demand for these investments has driven up the prices to the high end of the valuation range. That's why I hire a solid investment consultant to help design portfolios that dig a lot deeper than the big picture and long-term economic trends - and I suggest you do as well.
John P. Napolitano, CFP, CPA, PFS, is chairman and CEO of U.S. Wealth Management in Braintree, Mass.
