Many ways to dip toes in overseas markets
Thinking globally is a good way to spread the risk around, and investors have hundreds of options
The rationale for making equity investments around the world may seem to be getting weaker, but experts say there are still advantages to global diversification.
Don Reed, president and chief executive officer of Franklin Templeton Investments, reminds investors that Canadian stocks represent only about 3 per cent of global market capitalization.
"It's really a question of having more choice and more situations that might fit into your overall plan," says Mr. Reed, who is also lead manager of the Templeton International Stock Fund.
In investing terms, "global" means anywhere outside Canada, including the United States, and the rationale for investing there is the same as for spreading one's risk across asset classes.
A portfolio that includes assets that are not correlated - in other words, that don't react the same way to economic events or business news - will be less volatile over the long run.
The trouble is that all equities tend to behave in a similar way, says Danielle Park, president of Venable Park Investment Counsel Inc. in Barrie, Ont.
Even though the U.S. stock markets entered bear territory before those in Canada and Britain, in the end they all succumbed. Dan Hallett, a chartered financial analyst who runs his own consultancy in Windsor, Ont., agrees. "When you need diversification most, which is in falling markets, correlations do rise," he says.
With that strong caveat, they both agree that some geographic diversification makes sense - investors should consider holding 5 per cent to 10 per cent in international equities, and as much as 30 per cent in U.S. markets.
Self-directed investors will find hundreds of options, depending on how much time they devote to choosing their investments and how much they are willing to pay for advice from the experts.
For example, Globefund.ca offers more than 800 international equity funds that range from growth and value style investing to those that hold only dividend-paying stocks.
Mr. Reed at Franklin Templeton says he speaks a couple of times a week with 36 analysts in Hong Kong, Australia, Britain, Singapore and elsewhere around the world.
The team considers purchasing strategies, sometimes for as long as a month before they make a decision, Mr. Reed says.
His fund is most heavily weighted in Europe, where stocks are trading at lower price-to-earnings multiples compared with the rest of the globe.
"That's where the best bargains are available," Mr. Reed says. Stocks in Asia are also relatively cheap, he adds. Self-directed investors can also target specific regions. Canadian firms offer funds that focus on Europe, China, Japan, or the Asia-Pacific region minus Japan. Many also sell versions through discount brokerages with lower management fees than those available through financial advisers.
Still, the knock on mutual funds is that, over the long term, such passive investments as exchange traded funds (ETFs) and index funds tend to marginally outperform those run by active managers, which also charge 2 per cent and up in fees per year, a cost that eats into performance.
Exchange traded funds and index funds
The lowest-cost way to invest in foreign markets is to buy ETFs, which invest in a basket of stocks that mirrors a quantitative index. For example, the iShares S&P 500 invests in the main U.S. equity index and it's traded on the Toronto Stock Exchange. For that reason, self-directed investors need to own a brokerage account to access them.
Barclays Global Investors, which sells the ETF, charges a management expense ratio (MER) of 0.09 per cent, a small fraction of the costs of an actively managed U.S. equity mutual fund.
Ms. Park, who recommends solely ETFs for her clients, says she is considering the iShares ETF as an investment and also as a signal that the global bear market may be settling down. "We're watching it very closely to find out whether the equity cycle has turned yet," she says.
Later in the market cycle, she anticipates turning toward ETFs that track indexes in China or Brazil. "They're interesting, as long as you realize that the emerging economies are the most volatile," she says. They can rise slowly during bull markets and drop by half quickly in recessionary times, she adds.
The iShares MSCI EAFE exchange traded fund, which invests in Europe, Australasia and the Far East, is a "less volatile way to play the international story," she says.
Cost-conscious investors without brokerage accounts can access index mutual funds, which mirror the same sorts of indexes, from retail banks, Ms. Park says. They generally charge about 1 per cent in management fees.
American depository receipts
Theoretically, investors could build their own global portfolios of individual securities, but it's not as easy as trading stocks or ETFs with a Canadian online brokerage.
Canadians can buy U.S. stocks through their brokerage accounts, but for investments based outside North America they are limited to American depository receipts, says Mr. Hallett.
ADRs are U.S. dollar-denominated securities issued by U.S. brokerages in exchange for ownership in shares of a non-U.S. company. They were developed years ago to make trading in foreign securities easier, and they can be traded at any time through a U.S. brokerage.
"For example, you can buy Nokia on the New York Stock Exchange as an ADR," says Mr. Hallett.
Brokerage fees are higher than what an investor would pay for an online trade, however, and the settlement can take longer, too.
Special to The Globe and Mail