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Foreign companies have always seen the United States stock market as a very attractive place to raise capital for their businesses. This is thanks to the stock market’s highly transparent structure and the trillions of dollars in private capital from both retail and institutional investors.
As a result, the American markets have designed certain vehicles through which companies from other countries can list their equity instruments including the well-known American Depositary Receipts (ADRs) and funds focused on investing in companies located overseas.
If you are interested in learning how you can invest in top names from different corners of the world, the following article discusses what foreign stocks are, the pros and cons of investing in them, and how you can buy your first international shares through a regulated US-based brokerage firm.
What Are Foreign Stocks?
Foreign stocks are equity instruments listed by a corporation based outside the United States. Some of these companies list their shares by using one of the vehicles made available by American exchanges, such as American Depositary Receipts (ADRs) and American Depositary Shares (ADSs).
A US-based financial institution typically acts as the depositary for stocks listed through ADRs and ADSs. This institution is in charge of introducing and taking out shares based on the company’s equity issuance decisions and they are also responsible for distributing any dividends paid by the foreign company to US-based investors.
The first ADR in the US was launched in 1927 for a British department store called Selfridges. Back then, JP Morgan acted as the depositary institution.
Even though foreign companies have to comply with a set of rules to be able to list their equity instruments on a US-based exchange, these businesses are regulated by financial agencies from their home country. It’s important to note that many of the reporting, corporate governance, and auditing procedures of these financial agencies may differ from those of US-based corporations.
Therefore, investors should first understand the regulatory framework of the issuing company before buying a foreign stock while it is also important to assess the macro variables that affect the business, whether the company is a multinational or one with domestic operations only.
Beyond ADRs and ADS, investors have other options to invest in international stocks, like mutual funds and exchange-traded funds that track foreign markets, which we will cover in more detail in the following sections.
Pro Tip: There are a number of investment vehicles to invest in international stocks; from ADRs and GDRs to Mutual Funds and ETFs.
Ways to Invest in Foreign Stocks
There are multiple vehicles through which investors can get exposure to foreign stocks and, in the following section, we provide more details about them so you can pick the one that better suits your preferences.
1. International Stock Exchanges
The first way to buy foreign stocks is directly from the primary stock exchange the issue is listed on. In this regard, US residents can ask their US-based brokerage firm to buy a stock directly from the foreign exchange on their behalf.
However, keep in mind that this decision could be costly as most brokerage firms charge additional fees for holding foreign stocks while trading fees may also be higher than buying the US-listed version of the equity instrument (if it exists).
Moreover, certain taxes may apply when buying foreign stocks directly from their primary exchanges.
On the other hand, another way to buy foreign stocks directly from an exchange is to open an account with a brokerage firm located in the country where the stock is listed. However, this might be inconvenient unless you plan to invest frequently and in multiple corporations within that particular country and exchange.
Moreover, brokerage firms located overseas may not be able to open an account on behalf of a foreigner.
2. American Depositary Receipts (ADRs)
An American Depositary Receipt (ADR) is a certificate issued by a US-based financial institution that holds a certain number of shares of the foreign company that will be offered to US-based investors.
These instruments could trade over the counter (OTC) or they could be listed in a major exchange upon fulfilling certain conditions. It is important to note that ADR holders typically have the same rights that a regular shareholder would. This includes voting during the annual shareholder’s meeting and receiving any corresponding dividends.
ADRs can represent one or more shares of a foreign company. The number of shares that each ADR represents is known as the ADR ratio. A 2:1 ADR ratio, for example, indicates that one ADR contains two shares of the foreign business.
Through ADRs, brokerage firms in the United States can charge lower fees for trading foreign stocks as these instruments are listed in US-based exchanges.
3. Global Depositary Receipts (GDRs)
Similar to an ADR, a Global Depositary Receipt (GDR) is an instrument that represents a stock of a foreign company. However, it can be traded on different exchanges around the world.
The depositary institution that backs this instrument is typically a financial services firm with a global footprint. Companies issue GDRs to be able to raise capital from investors from multiple corners of the world and these vehicles facilitate the process of listing their stock on different exchanges.
GDR holders have the same rights as investors who hold the stock of the foreign company directly and there is also a GDR ratio that reflects how many shares of the business are bought for every GDR.
Pro Tip: GDRs (including dividends) are priced in the local currency of the exchanges where the shares are traded and are a easy and liquid vehicle to invest in international stocks.
4. Foreign Direct Investing
Foreign direct investment — also known as FDI — involves taking a large stake in a foreign company that is not necessarily traded on public markets. This kind of transaction is not usual for retail investors but high-net-worth individuals may get involved in these operations to get exposure to a foreign market.
One example would be to buy a 60% stake in a company based in Mexico. On the other hand, certain business structures may also make direct investments, as is the case of venture capital and private equity funds focused on businesses located overseas.
Investing directly in non-listed businesses can be highly risky and it is a sophisticated activity that may not be suitable for amateur investors who may not fully understand the intricacies of how the regulatory framework functions in the foreign market they are attempting to participate in.
5. Global Mutual Funds
Mutual funds are vehicles that give investors exposure to certain asset classes, sectors, and geographies. These funds hold a basket of instruments and, in the case of global mutual funds, they typically buy a group of promising foreign stocks following a pre-defined strategy.
Mutual funds typically charge a load fee and an annual percentage fee to investors and, depending on the fund, they could also require a minimum investment.
One example of this would be the Vanguard Global Wellington Fund (MUTF: VGWLX). This fund manages $1.8 billion in assets on behalf of investors at the moment and charges an annual 0.34% fee. The fund invests most of its assets in dividend-paying US and foreign companies while around 60% of its total allocation goes to stocks issued by businesses located overseas.
6. Exchange-Traded Funds
Exchange-traded funds (ETF) work similarly to mutual funds as they can provide investors with exposure to a diversified basket of foreign stocks following different approaches and strategies.
The benefit of ETFs compared to mutual funds is that they can be traded like a regular stock while there is no load fee. Additionally, expense ratios tend to be lower. ETFs do not require a minimum investment and users can either buy a single share or a portion of it if their brokerage firm offers fractional shares.
Two examples of ETFs offering exposure to foreign stocks are the Vanguard Total International Stock ETF (NASDAQ: VXUS) and the iShares Core MSCI Total International Stock ETF (NASDAQ: IXUS). The first charges a very low expense ratio of 0.08% per year while the latter charges a slightly higher annual percentage fee of 0.09%.
Pro Tip: ETFs that track foreign markets are probably one of the easiest ways to invest in international stocks. There are a number of ETF providers including iShares, State Street Global Advisors, Vanguard, Charles Schwab, First Trust, Invesco, and VanEck that offer these products. Make sure you understand their fees, liquidity, portfolio holdings, etc., before making your selection.
7. Invest in Multinational Corporations
One way to get indirect exposure to foreign economies is to invest in businesses with interests in multiple corners of the world — also known as multinationals.
There are thousands of companies that have operations in different regions and some are considered “global” businesses due to their elevated exposure to the world economy. Therefore, investors can choose to invest in businesses that either produce a significant portion of their revenues through their international subsidiaries or that have a presence in certain countries that have a promising future.
To identify these businesses, an investor would have to read the annual report of the company to understand how much of its revenue comes from international sales while, in most cases, detailed information on a per-region basis may also be provided.
Benefits of Investing in Foreign Stocks
- Further diversifies the composition of a stock portfolio.
- They act as a hedge against a potential deceleration in the United States economy caused by country-specific variables.
- Less developed markets may be riskier but they could also grow at a faster rate than advanced economies.
- There are multiple vehicles available to build a diversified position in foreign stocks. These vehicles tend to reduce both the costs and risks of investing in foreign stocks.
Downsides of Investing in Foreign Stocks
- Foreign stocks are subject to the regulations of their home country and these rules may be very different from those of the US.
- The cost of investing in foreign stocks directly could be very high and that could hurt returns.
- Foreign economies — especially underdeveloped ones — are more susceptible to changes in the macroeconomic landscape.
FAQs About How to Invest in Foreign Stocks
The following are some of the most frequently asked questions we get on the topic of how to invest in foreign stocks.
What Are the Risks of Investing in Foreign Stocks?
There are multiple risks that investors should be aware of when investing in foreign stocks and here is a summary of the most relevant ones:
- Currency risks: The performance of foreign companies is commonly highly sensitive to changes in the value of their home country’s official currency.
- Regulatory risks: Since domestic regulations of other countries might differ widely from those of the US, foreign companies can be affected by certain laws and rules in a way that US-based investors may not be fully aware of.
- Macroeconomic risks: Foreign companies are more sensitive to changes in the macroeconomic landscape of their domestic economies – especially those in less developed countries.
- Liquidity risks: Some foreign stocks are highly illiquid and that widens their bid/ask spreads. Meanwhile, investors may not be able to quickly liquidate their positions during times of extreme volatility unless they are willing to take a sizable loss.
Which Costs Are Associated with Investing in Foreign Stocks?
The costs of investing in foreign stocks include the following:
- Holding fees: Your broker may charge an extra fee for holding international shares in its book on your behalf.
- Foreign exchange fee: Some foreign exchanges may charge higher fees compared to US-based exchanges.
- Regulatory fees and taxes: Regulators may impose high fees for trading stocks listed in their home countries. Meanwhile, some countries like the United Kingdom charge a stamp duty fee per transaction for stock trading. Other countries may also impose similar fees.
- Currency conversion fees: If stocks are traded in a currency other than the US dollar, your broker may charge a currency conversion fee per trade.
Are Foreign Stocks Good for Diversification?
Typically, yes. However, foreign stocks may be more sensitive to changes in the economic cycle. In most cases, holding a small portion of foreign stocks may boost returns during an economic boom.
Which Brokers Offer Foreign Stocks?
The largest brokers in the United States, like Interactive Brokers, Charles Schwab, and Fidelity Investments, offer access to foreign stocks due to their global footprint. Each of these brokers charges different types of fees for trading these instruments.
Investing in foreign stocks can be quite challenging if you are not familiar with the factors that can affect the performance of these instruments including changes in their domestic economies and the evolution of global macroeconomic variables.
However, there are many vehicles through which you can incorporate a diversified basket of foreign stocks into your portfolio to gain exposure to a segment of the equity market that has commonly performed well under positive economic conditions.
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Alejandro is a financial writer with 7 years of experience in financial management and financial analysis. He writes technical content about economics, finance, investments, and real estate and has also assisted financial businesses in building their digital marketing strategy. His favorite topics are value investing and financial analysis.