Over the last few years, while US markets were recovering from the bursting of the dot-com bubble, the economies of India and China were booming. Compared to the Dow Jones Industrial Average’s dismal loss of 0.6% in 2005, India’s BSE index gained 42.3%, the Japanese Nikkei Index gained 40.24%, and Germany’s DAX 30 gained 28%. While US drivers continue to face rising oil prices that shot gasoline prices over the $3/gallon mark in many parts of the country, gas is cheaper than water in Venezuela (10 to 15 cents per gallon) sparking a boom in auto sales there. This may be very surprising news to investors in auto stocks such as Ford and GM, who watched their investments implode to barely half their value in 2005.
Traditionally, financial advisors have advocated for holding 15 – 20% of one’s overall portfolio in international stocks. There seems to have been a change in this sentiment recently, with some advisors recommending that as much as 50% of a portfolio be held in international stocks. Fear could be driving this trend. Fear that the real estate bubble might burst (the median price of a home in San Francisco/San Mateo is now around $750,000); that huge budget deficits could push the value of the US dollar over the proverbial cliff; of the long term effects of rising inflation and missing out on opportunities in emerging markets around the world.
Why Invest Internationally?
There are three main reasons why international investments should form a big part of your investing strategy. International investing can
- Serve as a hedge against your domestic portfolio of stocks and bonds. Hedging is often considered a big and mysterious word, but in the world of personal investing it boils down to something as simple as protection. International stocks may offer protection against a falling US market, protection against a plummeting dollar or protection against inflation. If protection against a declining US dollar is the objective, then care should be taken not to invest in markets (like China’s) whose currencies are still pegged to the US dollar.
- Reduce overall risk through diversification on an international scale, by lessening the chances that local catastrophes or recessions might wipe out a large part of your portfolio.
- Provide a much larger pool of companies to pick from. If you feel that the pharmaceutical industry is likely to do well over the next few years but do not like the growth prospects of domestic companies like Merck (Ticker: MRK) or Pfizer (Ticker: PFE), you might choose to invest in Switzerland’s Novartis (Ticker: NVS) or Israel’s Teva Pharmaceuticals (Ticker: TEVA) instead.
How can you invest internationally?
Make use of any of these three instruments that you have at your disposal.
Many of the brands you know and love are also brands that are known and loved by citizens of dozens of countries. Johnson’s Baby Soap, Colgate Toothpaste and Gillette are brands that are recognized all over the world and the companies that own these brands derive a large portion of their income from operations in other countries. For example, Johnson & Johnson (Ticker: JNJ), Colgate Palmolive (Ticker: CL) and Procter & Gamble (Ticker: PG) generate more that 50% of their income outside the United States. Even Ford, which is facing tremendous pressure domestically and losing market share to Toyota and Honda, grew its sales in China by over 46% in 2005.
American Depository Receipts (ADR):
ADRs are actually international stocks that are quoted on the US stock exchanges like the Nasdaq or NYSE. Large American brokers, like JPMorgan, usually facilitate this process. Commonly known and widely held ADRs include Nokia (Ticker: NOK) and Sony (Ticker: SNE). If you really like Panasonic TVs and think that the company could greatly benefit from the explosion in sales of flat panel HDTVs, you could easily buy the ADR of its parent company Matsushita Electric (Ticker: MC) in the same way you would buy a domestic stock like Dell. In most instances ADRs quote very close to the price of the stock in its domestic market, but in some instances it could quote at a premium to the value of the actual stock. To determine the premium associated with an ADR, obtain the price at which the stock quotes in its local market (Yahoo Finance is a good source) and convert it into US dollars. The difference between this amount and the price of the ADR is the premium you are paying for the ADR.
When I bought the ADR for Wipro Technologies (Ticker: WIT), one of the largest technology companies in India, the ADR was trading at a premium of almost 25%. In another instance, when I purchased the ADR for Tata Motors (Ticker: TTM), a large automobile company based in India, the ADR was trading at a value very close to the value of the underlying stock. Both these ADRs have provided outstanding returns over the last few months. Sometimes each ADR may represent a fraction of the underlying stock or, in some instances, two or more shares of the underlying stock. This should be verified first before determining the premium associated with the ADR, if any. A quick glance at the SINLetter Model Portfolio (http://www.sinletter.com/portfolio.aspx) will make it clear just how big a part international stocks play in my overall investing strategy.
Exchange Traded Funds (ETF):
For those of you who would prefer not to invest in individual stocks and/or have a more conservative investment strategy, ETFs could help provide the necessary international exposure. Exchange Traded Funds are like mutual funds, with one small difference. They can be bought and sold at any time like a regular stock from your brokerage account. ETFs also have very low expense ratios and hence provide an ideal low-cost vehicle for diversification. Investors who are interested in diversifying internationally can easily do so by buying an ETF, such as the iShares MSCI Brazil Index (Ticker: EWZ), which tracks Brazil’s Bovestpa Index. On the other side of the globe, Japan (emerging from a 15-year recession), is now showing signs of recovery. If you feel that there is still a potential upside to the Japanese market after the 40.24% run-up in 2005, you could easily invest in Japan through the ETF iShares MSCI Japan Index (Ticker: EWJ) which tracks the Japanese Nikkei index.
International investing has its risks but, if done right, it can serve as a balance, and reduce the risk of a portfolio that exclusively holds domestic stocks, bonds and mutual funds. Using the Internet and the vast number of free news services to keep informed about events around the globe, the world can easily become your investing playground.