Expand Horizons With International Investing

Look around you. The computer on which you are reading this was made in China. The wooden chair you're sitting on was crafted in Brazil. The foreign car in your neighbor's garage was manufactured in Asia.

If you aren't looking beyond the U.S. by taking advantage of international investing options, you're missing out on some of the best opportunities in the world to make money.

Michael Martin, chief investment officer of Financial Advantage, an investment management company near Baltimore, says some of the most obvious international investment opportunities are in China and India, which have enjoyed long-running manufacturing booms.

China, in particular, has grown 10% annually for the last 30 years, he notes. And though the growth rate in China or India may slow down at times, it hurtles forward at a breakneck pace compared to that of the U.S., with potential for more in the future. Output per person in the U.S. is $48,000, but in China, it's just $8,000 and it's only $4,000 in India.

"There are tremendous opportunities in these emerging markets as they embrace free-market concepts to close the prosperity gap," says Martin, adding that one-third of his company's investments are in emerging markets.

Nevertheless, they do hold risk, he warns.

  • Developing countries are dependent on exports. If the U.S. and other Western countries stop buying, then their business will slow dramatically.
  • Many developing countries are particularly vulnerable to shortages, inflation and politics because they import such basics as food, energy and industrial metals.
  • Doing business in developing countries isn't like doing business in the U.S. The legal standards are hazy, and there's no such thing as business transparency.
  • Intense poverty results in deadly uprisings, particularly in China and the Middle East.
  • Banks are owned by the governments, which freely manipulate currencies and credit.

But none of those factors are shockers, and unfortunately, they're not unique to developing countries. So Martin and other investment experts believe that the risks are manageable and the returns make it all worthwhile.

If you agree, here's how to get started.

Domestic Multinational Companies

If your tolerance for risk is low, stick with U.S.-based companies that do lots of international business. You can do that by buying individual stocks, actively managed mutual funds or domestic index funds that focus on large companies.

F. John Mathis, professor of global banking and finance at Thunderbird School of Global Management, says some U.S. companies -- PepsiCo, for instance -- make 50% or more of their revenues from foreign customers.

If you stick to U.S.-only investments, you'll avoid one risk of investing in foreign equities: the ups and downs of foreign currencies against the U.S. dollar. "The companies manage the foreign exchange risk, and you don't have to worry about it," Mathis says.

Foreign Companies and International Funds

If you're feeling a little braver, consider investing in the stocks and bonds of companies that are based outside the U.S. -- but whose products are household names in this country. Such an overseas investment might be Nestle, which is based in Switzerland. Its products include Gerber baby food, Stouffers frozen dinners and Kit Kat candy bars, among dozens of other familiar brands.

Jonathan M. Bergman, chief investment officer of New York-based Palisades Hudson Financial Group, says the easiest way to invest in these companies is to buy an international mutual fund focused on non-U.S. large-cap firms. He says you can dilute your risk by choosing funds that are well-diversified with respect to products and the places where the companies are based.

You'll still encounter some exposure to world currency shifts because the earnings of these companies are calculated in their home country's currencies. "I think that is potentially a good thing for investors," Bergman says. "We live our lives in dollars, but if there is inflation, we'll be happy that we have non-U.S. investments."

How does this work? Let's say you own stock in TD Bank, headquartered in Toronto. Its income is priced in Canadian dollars, colloquially called the "loonie." If the loonie rises in value against the U.S. dollar, when the return on your investment is converted from loonies to U.S. dollars, the conversion will put more greenbacks in your pocket than you would have gotten if you were a Canadian investor getting returns in Canadian dollars.

It can work the other way, of course. But at the moment, the U.S. government is printing a lot of dollars, and that pushes up the value of foreign currencies from places where this kind of currency inflation doesn't exist.

Mathias echoes the recommendation of investing in actively managed mutual funds. He thinks most U.S. investors are wise to shy away from ETFs based on foreign stocks and indexes. They are too confusing and too risky, he says. "It's like playing a lottery game with your money."

Emerging-Markets Bonds

If you're knowledgeable about world economies, the next step for international investors in search of yield is bonds in emerging markets issued in the country's currency, also known as sovereign bonds. The returns on these can be very attractive. "Sovereign bonds are in much better shape than those issued by the developed world," says Martin.

He sees what he calls "classic corruption" and heavy-handed crackdowns on unrest in China, and "rocky politics" in Mexico, Argentina and Brazil, which affect the economic picture. But overall, "The upside is fantastic. It's worth taking some risk," he says.

He urges investors in sovereign bonds to stick to investment grade and limit their purchases to bonds with maturities between four and five years. "Be well-diversified and liquid."

Aaron Katsman, a financial adviser with Portfolio Resources Group, is another enthusiastic emerging-markets bond investor. An American who is based in Israel, Katsman has clients worldwide. "American investors have done very well with foreign bonds," he says. "You can invest directly or through managed funds or ETFs. They have substantially higher dividends -- north of 5%."

Mathias is a little more cautious. He tells investors that if they want to buy foreign bonds or individual foreign stocks, they should identify "a money manager who has a very good track record in these markets."

"There is just a lot of risk," he warns. "The faster the foreign country is growing, the greater the risk. It's much easier to buy than it is to sell. You just don't have the protections that you have in the U.S."

Copyright 2012, Bankrate Inc.