It has been well publicized in recent years that Canada represents only 3-4% of both the world’s equity and bond markets. Also, broad portfolio diversification has been proven as the prudent investment style. Lastly, globalization of the world’s economies has been a notable phenomenon. These three factors all lead to the need or Canadian investors to pay proper attention to international investing in their long term strategy.
The advantage of diversification is achieved in various fashions. First, currency risk is reduced. The Canadian dollar is commonly measured solely against the American dollar. In fact, both currencies weakened against other major currencies in the mid-Nineties and did very well at the start of the new Millennium. Second, low correlation between international economies smoothes out returns over time. Third, larger economies offer greater depth of choices in certain sectors, e.g. the manufacturing and consumer sectors are not well developed in Canada compared to other countries. The Canadian stock market remains dominated by the resource sector. As a result, the Canadian market fares well when the economic cycle favors the resource industry.
There are different ways to approach international investing: mutual funds, indexes and direct investment. Direct investment carries the risk and burden of staying abreast of foreign markets. However, at further glance, this may not seem so onerous. Remember that the risks include: currency risk, country risk, industry and specific company risk. The purpose of international investing in the first place is to participate in currency and country risk for the benefit of portfolio diversification. Industry and company risks are risks that you bear in any equity market, including Canada’s.
The NYSE created American Depository Receipts (ADRs) in 1927 to facilitate foreign investing from North America. Today, several hundred are available. ADRs are part of a system whereby stock certificates of foreign corporations are registered in the name of a US financial institution and held in safe keeping on your behalf. You receive dividends and can buy and sell the certificates just like any other stock. One twist is that your foreign currency risk is whipsawed: you bear risk, in this case, in both the US dollar and the country of origin.
If this approach is too fraught with the unknown for you, you may be more comfortable with international investing closer to home, i.e. only in US stocks. The broader range of investment choices in a larger market may suit your needs. However, remember that there is a fairly strong correlation between movements in the Canadian and US markets.
The more conventional approach to international investing is to piggyback the greater expertise of worldwide investment managers in the mutual fund industry. Here, too, there are different approaches. One is to select a global fund with a good track record and leave the manager to it. The trick is that, unless you do some research on the particular fund, you may not know that, in fact, the particular fund is not particularly international at all! For instance, several international funds are heavily invested in the U.S. Alternatively, you may choose to have money spread around the globe by investing in funds with specific geographic agendas. There are American, European, Japanese, Latin American and Pacific Rim funds which invest exclusively in those areas.
Exchange traded funds are increasingly popular. These are market baskets created by an Exchange to mirror certain investing directives. For instance, “iShares” (formerly known as WEBs) exist for many geographic areas, including the US, Canada, key European countries, Japan, Hong Kong and Singapore to name a few. These have very low fund expenses and very low trading activity, like other index funds.