Tuesday, December 10, 2013

International investing: The risks and benefits

Disclaimer: I’m not advising anyone to follow my opinions in this article. It’s your money. Do whatever you think is best for you. I also do not guarantee the accuracy of any of the information presented in this article.

Whenever I meet a hot chick, I try to bring up the fact that I’m an international investor in the hopes of impressing her. It never really worked before, probably because it makes me sound like an arrogant douchebag. But the point of this article is not about my love life, but the additional risks and benefits of investing in foreign stocks.  Quite a lot of people feel that investing internationally is very risky. Yes, there are more sources of risks when it comes to owning foreign stocks, but foreign investments can also reduce other sources of risk. Overall, I don’t think investing overseas is any more risky than investing locally.  

The following are the additional risks of investing internationally:

Country risks: These are the risks inherent in the country the company operates in. There may be political instability and constant riots or a civil war might break out. Property rights might be weak in that country and the government might cancel the company’s license to operate or expropriate the company’s assets with little or no compensation. The country may have a lot of debt and/or run large budget deficits; this could lead to the country defaulting on its debt and going into a deep recession that could permanently impair the profitability of companies operating in the country. An asset bubble in the country could also lead to a deep recession. A history of high inflation is something to be cautious about as well.

Investors can significantly reduce country risks by investing in countries that are both financially and politically stable with a history of respecting property rights. You should also avoid countries that you think have a large asset bubble.

Foreign exchange risk: The currency in which a foreign company does business may weaken relative to your home country’s currency over the long-term and this could negatively impact your returns or even cause you to lose money on your investment in that foreign company. I will discuss what I think about this risk in the benefits segment of this article. Just know that it can’t be more risky than young Malaysians trading FOREX on their laptops while sipping coffee in some hipster café. Especially if you consider the fact that many of these “FOREX players” don’t know shit about finance.   

Not understanding tax laws: Some countries impose withholding taxes on dividends paid to foreign investors. Investors that do not take withholding taxes into account risk overpaying for overseas stocks. A U.S. stock with a P/E ratio of 10 or an earnings yield of 10% may seem reasonable, but a Malaysian investor’s effective earnings yield on the stock would only be 7% after taking into account withholding taxes of 30% on dividends. I’m taking a long-term view here and assume that all earnings will eventually be paid out as dividends.

Different accounting rules: There may be differences in how a foreign company accounts for items on its financial statements. Investors should go through the notes to the financial statements to ensure that the accounting is sound.  

Higher fees: Your broker might charge you higher fees to purchase and sell foreign equities. Make sure you take the higher fees into account when analysing the potential returns of a foreign company.

The following are the benefits of investing internationally:

Diversification: By having investments in multiple countries, you reduce the risk of adverse events in one country wiping out a very large amount of your capital. I live in Malaysia, and the country is both politically and financially stable. But even if there’s a 1% chance of the Malaysian economy crashing, I want to make sure that my portfolio doesn’t get absolutely destroyed if it actually happens.

Sure, I may be exposed to foreign exchange risk, but I think of my investments as generating profits in a basket of currencies. In my book, a basket of currencies is just as awesome as a basket of Japanese pastries. If one currency in my basket weakens against the Malaysian Ringgit, another currency in the basket might strengthen against the Ringgit. The countries I invest in are also politically and financially stable. So, the risk of all the other currencies in the basket weakening significantly against my home currency over the long-term isn’t really high.

By earning profits in multiple currencies, I’m also somewhat protected if Malaysia ever experiences a period of high inflation. Over time, a country with high inflation should see its currency weaken relative to currencies of countries with lower inflation. So, if Malaysia ever experiences a period of high inflation, the dividends I get from my foreign investments might buy me a larger amount of Ringgit. That means I might not need to cut down on fancy Italian dinners during periods of high inflation. International investing, BITCHES! That’s how I roll!

Take advantage of opportunities: As an international investor, you can take advantage of opportunities around the whole fucking world. If you just focus on your own country, you may be limited in the number of good companies you can invest in. Your local equities may also be overvalued and you can’t get a good long-term return investing in them. If you invest internationally, you increase the chances of putting together a portfolio of high quality companies at a reasonable price.

Over the long-term, Malaysian stocks have done well. Just 2 years ago or even early this year, you could find a lot of fantastic opportunities. But right now I’m really frustrated with Malaysian equities. The top quality stocks like Nestle and British American Tobacco are expensive. Malaysian business executives apparently have a fetish for palm oil estates and property development as a lot of Malaysian companies are involved in those sectors. I don’t like palm oil estates as it’s a commodity business and these type of businesses generally earn thin margins and below average returns on capital in the long-term.  For property development, who knows how long that party will last. Sometimes long-term investing doesn’t even pay off as the founders might decide to take the company private if the stock experiences a significant decline.

Well, thank you for staying till the end in this rather long article. I hope I addressed some of the doubts you might have about international investing. To the ladies reading this article, please drop me an email if you think international investing is hot. Take care and stay rational. 

1 comment:

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