Why invest in foreign markets
There are great reasons to expand your investing beyond the Canadian market:
- Diversify your portfolio.
- Potentially reduce portfolio risk and increase returns through exposure to global investments.
- Access to some of the world’s leading brands and industries (such as health care, auto manufacturers and pharmaceuticals) that aren’t widely available in Canada.
- Possibly reduce portfolio volatility because international markets and industries may react differently to those in Canada, even during similar economic conditions.
- Potentially higher returns for aggressive investors who invest small portions of a portfolio in emerging markets or global growth opportunities.
How to invest in foreign markets
Mutual funds and segregated funds
One of the simplest ways to invest in global markets is to invest in an international equities mutual fund or segregated fund. You can choose your level of investment risk, from conservative to aggressive, and choose by geography, for example, U.S. equities or global and regional equities.
Exchange-traded funds (ETFs)
These are also a convenient way to invest in the foreign market. Similar to mutual funds, some funds focus on a single country, while others cover a geographic region.
Direct investing
Through a stock brokerage service, you can invest directly in a foreign company.
Multinational corporations
You can invest in Canadian companies that have parent companies in other countries or operations in other companies and generate a lot of their revenue internationally. This isn’t actual foreign investing but it can provide investors with some international exposure.
Risks of foreign investment
There are risks attached to investing in foreign companies.
The effect of currency exchange on returns
If money is converted into foreign currency to make an investment, changes in the value of the Canadian currency, relative to the foreign currency, will affect the investment when it’s valued in Canadian dollars. So even if the investment itself has a positive rate of return, when converted to Canadian dollars, its value could turn out to be negative. The opposite is also possible.
Potential tax issues
Some foreign countries may withhold tax on foreign income, which isn’t recoverable in registered plans. Also, for non-registered plans, foreign dividend income doesn’t usually receive as favourable a tax treatment as Canadian dividend income.
Typically higher investment management fees and fund costs
These funds generally have higher management fees and operating costs (such as custody, trustee, trading and tax costs) than those investing exclusively in Canadian stocks and bonds.
Country risk in foreign investing
There is also a risk associated with the investment climate in various countries. These include the unique economic, political and business situations in a specific country that can influence a company’s stock performance.
Economic risk
This is a country’s ability to pay debt. Consider a financially stable country with a strong economy when foreign investing.
Political risk
This is the willingness of a country to pay debt or welcome outside investment. Sometimes the political decisions a country makes can result in investors losing money.
Sovereign risk
This is when a foreign central bank changes its foreign exchange regulations, reducing or nullifying the value of its foreign exchange contracts.
Types of foreign investment markets
Foreign markets are divided into 3 categories.
Developed markets
These are the largest, most industrialized economies with well-developed economic systems. They’re politically stable and abide by the rule of law. Developed markets are often the safest place to invest, but their economies may grow slower than countries in an earlier stage of development. Examples of developed markets include the United States, Canada, France, Japan and Australia.
Emerging markets
These markets exhibit fast industrialization and strong economic growth, which can sometimes provide better investment returns than developed markets. However, emerging markets can also be riskier than developed markets.
Emerging markets may be more politically uncertain and their economies may have more ups and downs. Many of the world’s fastest-growing economies, including China, India and Brazil are emerging markets.
Frontier markets
These are often smaller than emerging market countries or restrict foreign investment. They can be risky, yet also offer potentially above-average returns. Nigeria, Botswana and Kuwait are examples of frontier markets.
Measuring country risk
Countries are credit-rated by various large agencies. Those with a higher rating are generally considered to be safer to invest in than those with a lower credit rating.
- Canada’s current credit rating is AA+
- China’s current credit rating is A+
- Nigeria’s current credit rating is B