Stock investors on the hunt for diversification and growth potential often look to the wide world of opportunities beyond this country’s borders. It’s easy to see why.
The New York Stock Exchange and NASDAQ may top the list of the world’s 10 largest exchanges by market capitalization, but the next eight are all outside the United States.1 Among them are exchanges in global financial centers such as Hong Kong, Tokyo and several European capitals. These exchanges are home to thousands of companies, offering a diverse collection of potential growth, income and risk characteristics.
Many investors choose to take on international exposure through exchange-traded funds (ETFs), which can be a cost-effective approach to global diversification. But what if you’re interested in a particular international stock? Here, we look at the benefits and risks of three methods of trading individual foreign securities.
Trading foreign securities at home
If you’re looking to invest less than $5,000, your best option may be to invest in a foreign security trading in the United States. Trading volume for such a security likely won’t be as high as in the company’s home market, so prices may not be as attractive, but the relative simplicity of trading at home may have other advantages.
For smaller orders, an American Depositary Receipt (ADR) is a straightforward option. An ADR is a certificate representing a specified number of shares in a foreign company listed overseas. These securities are issued by a bank or brokerage firm that holds the underlying shares. They trade like stocks on U.S. exchanges and in the over-the-counter (OTC) market—a computer- and telephone-based system in which competing broker-dealers, known as “market makers,” negotiate directly with each other to price securities. In either case, trading occurs during U.S. market hours, and trades are reported in U.S. dollars. Prices reflect changes in the value of the company’s shares at home as well as currency fluctuations.
Some of the advantages of ADRs are that the issuing firm will collect any dividend payments and convert them into U.S. dollars for you. Also, ADRs listed on an exchange must file quarterly results because they are registered with the U.S. Securities and Exchange Commission and are subject to U.S. accounting rules. This means investors potentially have access to more information than they would if they’d invested directly overseas.
Keep in mind, though, the institutions that issue ADRs charge investors annual custody fees, which are detailed in an ADR’s prospectus. When ADRs trade on exchanges, they are subject to regular stock trading commissions. Also, liquidity for some ADRs may be low, which may affect bid/ask spreads. Finally, not every foreign company has an ADR. Usually only larger firms in developed countries offer them.
If an ADR isn’t available, you may be able to trade the company’s foreign stock in the OTC market. This is known as trading “foreign ordinaries.” The OTC market has become increasingly attractive to international companies in recent years due to the rigorous reporting requirements and related expenses involved in listing on registered exchanges. Again, trades are in U.S. dollars and take place during U.S. trading hours.
One consideration with trading foreign ordinaries in the OTC market is that market makers may mark up the price to cover currency and other risks associated with maintaining an inventory of foreign securities. These trades may also be subject to a foreign transaction fee, and foreign ordinaries in the OTC market may not be as liquid as a security trading on a local exchange.
Finally, because companies trading in the OTC market have minimal reporting requirements and aren’t required to file quarterly results with the SEC, it’s more difficult to research them.
Trading in overseas markets
If you’re planning to invest more than $5,000, the best approach is probably to invest directly on a foreign company’s home exchange. One of the main advantages in going directly to an overseas market is that local market trading tends to be more liquid, which generally means you’ll get better quotes than if you were trading at home.
You can generally place broker-assisted trades overseas in a brokerage account using U.S. dollars. Some specialized accounts allow you to trade in the local currencies (see sidebar). Orders are executed during local market hours, and if trades are made after local hours, they are placed in a queue and executed when the market reopens.
Trading overseas may involve a variety of transaction fees and taxes. Some countries impose controls that restrict or delay currency conversions for overseas traders, meaning it can take time to access your funds. Reporting, clearing and settlement of trades may add additional time. You also may be required to place trades in round lots (standard trading amounts).
Here, too, research can be difficult since foreign countries have different rules and regulations for reporting, and reports may not be in English.
What are the risks?
Investors who trade foreign stocks will have to think about risk, particularly currency and country risk.
Currency risk. When you invest in a foreign security, you’re exposing yourself to the possibility that weakness in a company’s local currency will erode the value of your investment in U.S. dollar terms (on the other hand, a strong local currency will inflate that value). Consider the performance of the European stocks measured by the STOXX Europe 600 Index. The index posted a total return of more than 7% in January 2015 in euro terms, the best start to a year for European stocks since 1989.2 However, calculated in dollar terms, the index was flat (0.07%), reflecting the euro’s weakness.
Country risk. You’re also taking on the risk that political or economic events in a foreign company’s home country will harm your investment.
Russia is an example of how the two types of risk can work together. Sanctions related to Russia’s foreign policy, combined with the country’s heavy reliance on oil exports at a time when prices were falling, have wreaked havoc with the Russian stock market and depressed the value of the ruble. U.S. investors who bet on Russia in 2014 had a rough time. The Russian MICEX Index returned a loss of 2.09% (including dividends) for the full year in ruble terms. Calculated in dollars, the drop was 42.1%.3
1Calculation in U.S. dollar terms by Charles Schwab using data from the World Federation of Exchanges. Data as of 12/2014.
2Calculation by Charles Schwab using Bloomberg data as of 2/4/2014.
Schwab Global Account
Direct foreign market access
The Schwab Global Account™ allows you to execute real-time online trades in 12 countries during local market hours, using local currencies.* You can also trade ADRs on U.S. exchanges and foreign ordinaries in the U.S. OTC market using U.S. dollars.
Here are some other benefits:
- No fee to open or maintain an account. No trade minimums. (Other account fees, fund expenses and brokerage commissions may apply.)
- Multi-currency statement reporting.
- Assistance from Global Investing Specialists.
For more information, visit schwab.com/globalaccount or call the Global Investing Services desk at 877-806-4209.
*Real-time quotes are not available to professional investors.