Smart investment decisions do not always produce instant investment profits. Take international investing. The smart play is to have exposure to international stocks. It’s estimated that overseas stock markets account for well over half of the global stock. Thus, to ignore international stocks means to ignore a huge opportunity set for finding winners.
And yet, owning international stocks hasn’t exactly helped portfolios in recent years. Indeed, you would have been far better off owning exclusively U.S. stocks. The chart below shows the five-year performance of three exchange-traded funds —iShares MSCI EAFE (Europe, Australasia, Far East) Index Fund (EFA), which represents developed foreign markets; iShares MSCI Emerging Markets Index Fund (EEM) and the iShares S&P 500 Index Fund (IVV). The iShares S&P 500 Index ETF of large-cap U.S. stocks has handily outperformed the two foreign index ETFs over the last five years.
Why Own International Stocks?
These return numbers beg the question—why own international stocks? It is important to remember that these numbers represent a fairly small snapshot in time. Furthermore, the numbers here represent index returns and don’t necessarily mean that well-chosen foreign stocks did not perform as well or better than many U.S. stocks during this five-year period.
The bottom line is that it is a smart idea to include international investments in a portfolio. Foreign stocks are trading at attractive valuations versus U.S. equities. Furthermore, dividend yields on average are higher abroad than in the U.S. For example, the yield on the MSCI EAFE is approximately 3% versus 2.1% for the S&P 500 Index. Thus, I expect the pendulum to start to swing back in favor of international stocks, and you may see that swing accelerate as soon as 2017.
For individuals who want exposure overseas, the investments of choice typically are foreign mutual funds and exchange-traded funds (ETFs). However, investors who like to buy individual stocks are not left out of the party. Indeed, many foreign companies have their shares listed on U.S. exchanges, and many of those companies offer dividend reinvestment plans.
ADRs and DRIPs Offer Easy Access to International Markets
More than 200 foreign stocks allow any U.S. investor to buy their share directly, the first share and every share, without ever having to call a broker. In these direct-purchase plans, U.S. investors are buying American Depositary Receipts (ADRs). ADRs represent ownership in shares of foreign companies. Investors buy and sell ADRs just as they buy and sell U.S. stocks. ADRs are quoted in U.S. dollars and pay dividends in U.S. dollars. And those dividends, in many cases, receive the current preferential tax treatment afforded qualified dividends paid by U.S. companies.
ADRs can be purchased via a stockbroker. Alternatively, many ADRs allow investors to buy stock directly with their direct-purchase plans. ADR direct-purchase plans operate the same way as U.S. direct-purchase plans. Investors obtain enrollment information either by calling toll-free numbers or downloading enrollment information from the transfer agent websites. Transfer agents are the entities companies hire to administer their plans. Transfer agents for most ADR direct-purchase plans are:
• J.P. Morgan (www.adr.com)
• Citibank (www.citi.com/adr)
• Computershare (www.computershare.com)
• American Stock Transfer and Trust/Deutsche Bank (www.amstock.com; www.adr.db.com)
• Wells Fargo Shareowner Services (shareowneronline.com)
The terms of ADR direct-purchase plans are similar to U.S. plans:
1. Minimum initial investment is usually $200 to $250.
2. Subsequent investments are usually $50 to $100.
3. The fee on the initial investment is usually $10 to $18.
4. Purchase fees on subsequent investments are usually $2.50 to $5 plus $0.08 to $0.12 per share.
5. Selling fees are usually $5 to $15 plus $0.10 to $0.15 per share.
There are some Risks to Global Investing
There are a few things to keep in mind concerning dividends on foreign stocks:
• Frequency. ADRs typically pay dividends either annually or semiannually.
• Currency impact. ADR dividends will be impacted by currency exchange rates, so future dividends can fluctuate.
• Tax withholding. A portion of dividends paid on ADRs may be withheld for foreign tax purposes, although investors can recoup that money by filing for a foreign tax credit when they file their taxes.
While overseas investing can spice up the returns of your portfolio over time, it is not without special risks, including:
Political risks matter, as they create instability and uncertainty, which investors hate. Furthermore, political shifts can lead to significant economic shifts in a country, which can impact such things as trade, capital markets, and corporate profits for companies operating in those regions.
Currency risk, as fluctuations can have a big impact on the business and equity performance of foreign companies.
Economic risk. Because of their size and politics, foreign economies tend to be less stable than the U.S. Another factor that impacts a lot of foreign economies, especially in emerging countries, is their dependence on commodities.
Inflation risk, as interest rates, inflation, and corporate profits are the main drivers of stocks prices. Rising inflation is typically bad for stocks.
Information risk. There are information gaps when it comes to obtaining the necessary data points on foreign stocks, which may make it difficult to have a lot of confidence in your analysis.
Transparency risks, related to information risk. U.S. stock markets are perhaps the most transparent in the world. Accounting scandals, while they do occur periodically, are fairly uncommon. That is not necessarily the case in certain foreign markets.
Despite the risks, investors should not be scared off from investments in quality foreign companies.
Wall Street’s Best Editor’s Note:
In today’s issue of Wall Street’s Best Investments, Charles Carlson offers another ADR for your review. Here’s a sneak peek:
Ireland-based Shire plc (SHPG) is best known for its products to treat attention deficit hyperactivity disorder (ADHD). The firm expects the combination to deliver over $20 billion in annual revenue by 2020. Shire’s drug pipeline looks promising, with more than 50 programs in clinical development. These shares trade at a 28% discount to their 52-week high of $270 and offer plenty of upside.
Editor, Wall Street’s Best Investments and Wall Street’s Best Dividend Stocks