Investors wanting direct exposure to a particular geography or investment theme that may not be covered by the funds in their home market can invest directly in overseas companies, but these investments bring risks that would not exist in the domestic market.
Factors such as country risk, currency fluctuations, share class, free float requirements, tax stipulations, market correlation and corporate governance requirements must all be taken into account when considering adding overseas investments to a portfolio.
Elaine Coverley, head of equity research at Brewin Dolphin, said, “London, along with the US and Europe, has some of the highest standards of regulation and corporate governance in the world, and you may not be protected in this way when directly investing in other, less developed, markets.
“Tread carefully when investing in overseas equities.”
Awareness of country risk, including political, social, or economic instability is essential since a sharp rise in volatility could impact long and short term equity performance.
Foreign exchange rate movements have the potential to undermine any returns made through a company’s performance alone, which poses a risk to the value of equities in the investor’s domestic currency, although this is also a threat to pooled investments.
However, overseas holdings may serve as a hedge in the case of a depreciation of the investor’s domestic currency. If the pound falls, holding capital in foreign investments may help offset losses.
Investors should consider which share class they purchase to reap the benefits of a particular exchange, as many overseas companies have dual listings in both their home market and another - often London - which offers greater liquidity.
Corporate governance requirements are very strict within the UK, but some overseas markets, such as Kazakhstan or Russia, are not so rigid. A company operating in a market with lax governance may not operate in the best interests of all shareholders and may not adhere to reporting standards or tax regulation.
The London Stock Exchange requires that all companies have a free float of at least 25 per cent, while other markets may have a lower requirement. This potentially exposes investors to greater risk as it allows a much lower free float.
Different jurisdictions have different withholding taxes, so investors may not always receive all of the dividend income they might expect.
Investments may already be more diversified than some investors realise, as significant exposure to foreign markets may be achieved even when investing in a domestic market such as the FTSE 100, which provides around 75 per cent exposure to overseas earnings.
Major international markets do not exist in a vacuum and have a tendency to be highly correlated, so if the UK market falls investors may suffer similar losses on overseas equities.
“Holding a stock directly does have its benefits, but also consider gaining exposure via a managed fund or ETF to help manage risk,” Ms Coverley said.
