If this picture doesn’t scare you away from investing altogether, then you should seriously be considering investing globally. There is no single market that guarantees good or safe returns. The bargains are dispersed more and yet more accessible than before. Thanks to technology, even the retail investor with limited resources can look through thousands of companies worldwide to find value. In this context, focusing on your home country is an even worse idea than usual.
I am not going to say anything new or profound here. I will just go over the major inhibitions, conscious and unconscious, that may be stopping you from taking full advantage of the abundance of opportunities out there.
Generally, the barriers to international investing are:
- A lack of familiarity with foreign markets. It’s only natural that people feel comfortable with the things they know. As far as common business and social norms are concerned, there is a good basis for investing at home. To some extent, however, this feeling of familiarity is illusory. In fact, as long as reliable, timely and transparent information is available freely, you can be as familiar with a foreign market as with your home market.
- Political risk. It takes a leap of faith to trust a foreign company with your money. Countries get overburdened with debt. Political leaders act unpredictably. Currencies depreciate. There is lots of risk in countries with shaky regimes and limited free market tradition. Recently, however, developed countries have demonstrated that their politicians can be just as reckless. So, it’s up to you to decide how much weight to put on this risk.
- Market efficiency. This includes market liquidity, capital controls, timely and reliable information, price manipulation, and insider trading. These are all valid concerns when considering a foreign investment. The investor has to be comfortable with the playing field he is going to play on. Deciding whether to play abroad, under their rules, is something you have to make up your mind about at the start.
- Regulations. Great global deregulation has taken place in the past century. Most barriers to foreign investment have fallen. And this trend will continue, with the occasional tightening after a major crisis. For countries that don’t regulate business too heavily and don’t restrict foreign ownership, this shouldn’t be an issue.
- Transaction costs. Among others, these include brokerage commission, stamp tax, price impact and custody costs. For investors of moderate means, these can add up to a substantial percentage of their assets. A cost-benefit analysis is in order. Again, the trend has been beneficial and transaction costs today are a small fraction of what they have been back in the day. There are discount brokers, although those doing business internationally are few, who offer extremely low fees. As a rule of thumb, an efficient investment operation will keep annual costs below 1% of assets. You have to consider the extra return you can get abroad in relation to the additional expenses you are going to incur there.
- Taxes. Mostly, you’d be interested in the withholding rate in the foreign country and any treaties for avoiding double taxation that your country and the foreign country have signed.
- Currency risk. This one confuses many small investors and turns them away from investing abroad. But it shouldn’t. Currency risk can be hedged or left alone, depending on your opinion or lack thereof about the direction of future exchange rate movements. However, it’s a broad topic and I will consider writing a follow-up in the coming days to address it.
All in all, these are the major concerns people have when considering stepping outside of their home country. As you can see, some are just psychological barriers that one can (easily) conquer, others are risks that can be managed, and still others are outside your control — things you have to live with or stay away from.
The most important matter to ponder is your expectations about incremental returns, incremental risk and incremental costs. With the abundance of depressed markets, emerging markets, all sorts of markets, it is very narrow-minded to look only at your home market, even if it happens to be the U.S. market.
There was a time when the NYSE was the only significant market in the world and represented some 60% of world market cap. Maybe then international diversification didn’t make so much sense. Today the U.S. equity market is just over 40% of the world market, according to this Credit Suisse paper. Europe makes up one-third of the world market and Asia-Pacific is one-fourth.
Think about it.