Looking at the best ways to obtain international exposure

The term “global” is used to describe the entire world.   As an example, a global mutual fund could be primarily invested in Canada and/or the US, as it is part of the world.

The term “international” is used in Canada to describe investments outside of North America.  Picking international investments outside North America comes with a few additional challenges.

Many Canadians are comfortable investing in domestic or North American companies, this is known as home country bias.  We feel investors can be successful sticking close to home when selecting investments.   We also feel that opportunities are available for investors who want to venture outside of Canada.

Five years ago, the market capitalization of the US and Canada was 49.4 per cent and 2.6 per cent, respectively.  These two countries combined represented 52 per cent of the world’s market capitalization.

Today, the market capitalization of the US has dropped to 43.1 per cent and Canada has increased to 4.7 per cent.  Combined, the US and Canada has dropped to approximately 47.8 per cent of the world’s market capitalization.  This represents a decline of 4.2 per cent.

The primary reason for the above drop in the combined US and Canada is the significant increase in the emerging markets.  The current weighting between developed and emerging markets is 86.37 and 13.63 per cent, respectively.  Below we have noted the changes in the BRIC (Brazil, Russia, India, and China) countries, the four most commonly referred to emerging markets.

The BRIC markets
  Then Now
  Dec 31, Dec 31,
Country 2005 2010
Brazil 0.5% 1.99%
Russia 0.2% 0.79%
India 0.4% 1.15%
China 0.4% 2.34%

Source:  MSCI All Country World Investment Market Index

Growth versus Value

The terms “developed” and “emerging” could almost be stated another way.  Developed market countries (Top 10 By Country Weight:  US, Japan, United Kingdom, Canada, France, Australia, Germany, Switzerland, Sweden, and Spain) could be compared to value investing.

Emerging market countries (Top 10 By Country Weight:  China, Brazil, Korea, Taiwan, India, South Africa, Russia, Mexico, Malaysia, and Indonesia) could be compared to growth investing.

International Companies – if you own a large US and/or Canadian company then chances are you already have some international exposure.  Some companies may have a stock exchange listing in either the US or Canada but still generates significant revenue from non-domestic operations.  One approach to increasing foreign content is to focus on North American companies that derive revenues outside of Canada and the US.

US Equities – in allocating foreign investments to the US, 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 staples, and technology.   Canadians are able to purchase publicly traded securities through US exchanges.

ETFs – Exchange Traded Funds (ETFs) and Index Shares (iShares) 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.

ADRs – 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.  ADRs are generally quoted in U.S. dollars and trade on U.S. exchanges.

Mutual Funds – 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.

Know the Risks

Prior to diving into foreign investments it is important to understand some of the main risks:

  • Currency Risk – one of the main risks to foreign investments is currency fluctuations.   Another factor that is critical when looking at foreign investments is the impact on changes in exchange rates compared with the Canadian Dollar (CAD).  Some ETFS and mutual funds attempt to minimize currency risk by employing various hedging strategies.
  • Political Risk – foreign governments may interfere with the operations of local corporations.  The stability of the government is certainly important for investors to get comfort on policy and taxation changes.
  • Regulatory Risk – many companies may seek out those countries with relatively weak regulations.  Foreign governments may be inclined to change various regulations which disrupt capital markets.
  • Liquidity Risk – the term liquidity refers to the availability of an investor to access or convert the investment into cash.   Many foreign investments have restrictions that limit the amount of trading or the frequency with which an investor may request redemption.  A market is considered liquid if an investor can convert the investment easily into cash.   Trading volume and bid-ask spreads are key indicators of liquidity.
  • Accounting Standards – There are economies around the world that do not have established accounting and auditing standards.  Others are quickly scrambling to catch up.  It is near impossible to assess the merits of an investment without true and accurate financial statements.  If financial statements exist they may be in a foreign language unknown to the investor and the standards may be different from domestic requirements.