As more and more investors look abroad for investment ideas, we have put together a series that seeks to illuminate some of the risks and rewards related to international investing. Over the next four days, we hope to uncover a few international superstars.
International investing is still something of a wild frontier for many investors. While most investors have at least a vague understanding that there's money to be made from non-U.S. companies, most people seem to have a sharper recollection of the periodic swoons and crashes that have hit then-hot markets, such as Mexico, Brazil, Japan, or the Asian Tigers.
Yet we are reminded nearly every day that even if we own only stocks of companies based in the United States, we are still investing overseas -- almost by default. A terrorist attack in London momentarily shook up our markets. Companies are rushing to exploit opportunities in China. Raw materials sourced from around the world are critical to the smooth operation of our economy. Any way you slice it, it's almost impossible not to have some degree of international exposure in your portfolio.
I make the case that individual investors would do well to take a more direct approach. Not only is there money to be made from companies headquartered off our shores, but such investments can also reduce the overall risk and volatility of your portfolio. Let us make our case for why investing abroad can be quite Foolish indeed.
Diversification
Although it is true that global economies are increasingly intertwined, there is still ample room for country-specific fluctuations. Internal economic policies and business conditions still matter, and one country's bane can be another's boon. If oil and raw-material prices have had a dampening effect on the U.S. economy, they've been good news to some extent for countries like Australia, Canada, and Norway.
While the United States market is pretty well correlated with the world as a whole, it is less correlated with individual foreign markets -- and that's an opportunity for diversifying your risk. Broadly speaking, most U.S. stocks will go up in a bull market and down in a bear market. But history shows that during a given time period, shares in Finland or Japan can be performing in opposite directions. Keeping a small part of your portfolio invested in foreign companies can, thus, allow you to make more and/or lose less than staying fully invested solely in American equities.
Exploit the inefficiencies
Although the gap is not as large as it used to be, there are some inefficiencies in overseas markets that investors can exploit to their own advantage. Not only is individual investor participation in the markets less common overseas, but also many investors shy away from overseas investment because of misperceived risk. That's an opportunity for the braver Fools among us.
Many companies in this country are covered extensively (even if not very well) by hordes of analysts working for investment banks, mutual funds, and other investment companies. The merits and drawbacks are discussed extensively, and it can be very difficult to find an investing "edge" pertaining to unknown or underappreciated information. That's not necessarily the case in many other countries, and that means that the odds of finding a hidden gem are better.
What's more, many investors steer clear of foreign stocks because of an overestimation of the risks and hassles involved. Whether it's the fear of currency fluctuations or insufficient integrity in financial reporting, worries about government interference or the hassles of foreign taxation, many investors just don't bother. While some of these risks are entirely valid, they don't apply equally across all companies or markets. But if investors are scared off, that means more bargains for the intrepid.
The "next Microsoft" might be Indian, or Chinese, or Russian .
The United States has an incredible entrepreneurial spirit, and that has led to the constant creation of exciting and dynamic new companies -- precisely the sort of game-changers that can make a lot of money for savvy and patient investors. That said, it seems that the U.S. is slowly losing its exclusivity in this department -- not because Americans are becoming any less entrepreneurial, but because the rest of the world is catching up.
Look at creative, inventive, and aggressive executives like Richard Branson at Virgin, Masayoshi Son at Softbank, and Lakshmi Mittal at Mittal Steel
Exceptional growth, improving standards
I would be remiss in not pointing out one of the biggest motivations for many overseas investors -- growth. Simply put, many economies around the world are growing faster than ours, and they're likely to continue to grow at a higher rate for the foreseeable future. Countries like China, Turkey, and Thailand are all growing quite rapidly, and though there are always risks of inflation and setbacks, most people expect these economies to continue growing at a healthy clip for many years.
What does growth mean? It means more jobs and more prosperity for the people of those countries and more opportunity for the companies that operate in those areas. More wealth in Mexico means more demand for Cemex
It's also important to note that along with growth come better financial controls and disclosure in many countries. People overseas are not dimwits; they realize that there is a huge amount of capital in the United States to fund their growth plans but that they can't get at it unless American investors are made to feel comfortable. In the years that I've been closely following international markets, I've seen definite progress in this regard, and I would expect international financial reporting standards to continue to improve and evolve.
Risks
It is certainly true that investing in foreign companies can be risky. Not only can foreign currency movements erase gains or magnify losses, but so, too, can government policies and behavior. Governments in some countries play fast and loose with laws and regulations, and some are all too willing to soak foreign investors for the benefit of the voters back home. It's also true that many governments have a difficult time managing the demands of growth, financial discipline, and social welfare and that periodic screw-ups can cause hard times.
But let's keep this question of risk in proper perspective. While it was certainly possible to lose a lot of money a decade or so ago in Thailand or Indonesia, how did investors in all-American companies like Enron and Krispy Kreme make out? If enthusiasm for Chinese or Brazilian stocks has created a bubble in the past, is that any different from our country's very own tech bubble a few years back?
It is absolutely true that investing overseas can be risky. It is also true that some of the risks are greater than with domestic stocks. But for discerning investors who can analyze risk and make sure that the potential rewards adequately compensate for the risk, it shouldn't be a deal-breaker.
Our bottom line
While we at The Motley Fool don't believe you have to invest overseas to have long-term success, we do believe that it can improve your overall investing performance. Some of our very own newsletter advisors have seen the virtues of overseas equities. Stocks like Brazil's Embraer
It can be difficult to make those first tentative steps into international investing, but once you do, you literally open yourself up to a world of profitable possibilities. There's no need to go overboard and become a globetrotter like John Templeton or Mark Mobius, but Fools may find that reserving 10% or 20% of their portfolios for international investing gives them the best of both worlds -- more growth for less overall risk.
To learn more about our coverage of international investing, click here.
For related Foolishness:
Embraer is a Motley Fool Stock Advisor selection; NetEase is a Motley Fool Rule Breakers pick; Unilever has been recommended in Motley Fool Income Investor ; Lloyds TSB is a Motley Fool Inside Value selection.
Fool contributor Stephen Simpson owns shares of America Movil. The Fool has an ironclad disclosure policy.
