The last two columns discussed the importance of having foreign investments within a diversified portfolio. We also highlighted some of the inherent risks. Today, we will look at the most common methods investors can use to obtain foreign exposure.
Where to begin?
We are fortunate today to have a variety of different foreign investment options available. The four most common methods of obtaining foreign exposure are through direct US equities, Exchange Trade Funds (ETFs), American Depository Receipts (ADR) and Mutual Funds.
In allocating foreign investments to the U.S., investors should be looking for both diversification and sectors that have a competitive advantage over their Canadian counterparts. This is where US equities can play a unique part of a diversified portfolio in sectors such as health care, consumer goods, and technology. Canadians are able to purchase publicly traded securities through US exchanges.
Exchange Trade Funds (ETFs) are designed to closely track a domestic index, foreign index or specific sector. They provide easy access to a wide variety of Global and International indexes. When you invest in ETFs, you know exactly what you’re investing in as their components are generally disclosed every trading day. ETFs have become a popular and simple way to add market exposure in a highly diversified, cost-effective way. Investors buy and sell shares of ETFs on Canadian and U.S. exchanges.
American Depository Receipts (ADRs) is one system of purchasing individual foreign securities through an American trust company or bank, which holds the security in safekeeping. Some household names that trade as an ADR are: Toyota Motor Corp, HSBC Holdings, ING Group, Sony, etc. ADRs are generally quoted in U.S. dollars and trade on U.S. exchanges.
For years mutual funds have marketed the merits of investing in areas such as Asia, Europe, Latin America, The Middle East and Africa. Our view on all mutual funds is that you have to be very selective, ensure that the portfolio manager has a proven methodology and a good track record. Always consider the liquidity of each investment and the associated costs if you should decide to sell. Some investors may own “International” and/or “Global” mutual funds. There is a difference. An “International” mutual fund generally refers to those that invest in securities outside of North America with no investments within Canada or the U.S. A “Global” mutual fund invests throughout the world, including Canada and the U.S.
How much foreign?
Until this year, the government imposed a maximum limit of 30 per cent foreign content within registered (RRSP, RRIF, etc.) accounts. This was eliminated with the 2005 federal budget approval. With the removal of this regulation, many individuals may be left wondering what percentage of foreign investments they should hold. Investment advisors should be able to assist you in determining the appropriate asset mix. Remember to look at your Investment Policy Statement to ensure that the portion allocated to foreign investments is consistent with your overall investment strategy.
Investors may still feel uncomfortable branching off into foreign investments. This uncertainty is not uncommon and a prime reason for discussing foreign investment options with your investment advisor.