Is There Risk Investing in the Companies of Foreign Nations?

Shutterstock

There are unique and differing risks when it comes to investing in foreign stocks compared to public companies in the United States traded on the U.S. stock market exchanges. I will cover these risks in some detail, but the conclusion I want you to draw from these risks is that you had better attach a hefty premium in terms of the potential return you are seeking to compensate you for taking these additional risks. Most U.S. investors apply U.S.-learned basic analysis to foreign company investment opportunities. At the end of the article, I will describe a real-life example of George, an MBA, CFA, and experienced investor, who was financially hammered when he invested in a Chinese company called Alibaba.

There are many ways and means to address the markets overseas in terms of the investment vehicle you choose. You can select from:

• A broad international portfolio
• A portfolio focused on emerging markets or developed markets
• A specific region, such as Latin America or Europe
• A specific country or countries, such as China or more in the Asia Pac region

Here are the risks:

1. Economic risk. On a national level does the country have a balance sheet that gives us assurance that they can meet and pay their debt obligations? Financial stability comes from economic growth, lack of excessive debt, inherent wealth in the form of natural resources and an educated workforce, and a government that encourages investment, capitalism, and competition.
2. Political risk. This requires good understanding of the government, its priorities, and its policies. Would you invest in your own business in the country? If so, you believe the political climate is conducive to run a good business and grow it profitability. Far more difficult—but equally important—is to assess the future of government and policy. If instability coming from a discontented and disenfranchised citizenry threatens the existing order, or if outside powerful groups seek to change or even topple the status quo, we need to connect those possibilities to our investment decision.
3. Sovereign risk. This risk applies more to bonds than to stocks and is probably too complex for the average investor to evaluate, but we list it because it too is a real risk. The nature of the central bank and its policies and regulations regarding foreign exchange are an important factor to consider. This is especially true if you are evaluating a potential investment in the country’s bonds.
   Credit ratings to assess a country’s ability to repay its debt are available from Moody’s, Standard & Poor’s (S&P), and other large rating agencies. In addition, other sources of information that cover the economic and political climate in foreign countries can be found in the New York Times, Wall Street Journal, and Financial Times, as they have a heavy focus and extensive coverage of overseas events. The weekly publication of The Economist is another excellent resource.
4. Currency risk. Currency fluctuations change the value of your return when it gets converted back into U.S. Dollars. This can result in additional, incremental investment gains or losses, solely the result of whether the U.S. Dollar is strengthening or weakening against the foreign country currency.

Now let’s turn to George and his investment in Alibaba. A real-life example is always the best way to illustrate the risks listed above. George followed the advice of great investors. Influencers such as Charlie Munger and Ray Dalio were recommending China and emerging market investments. Under the former Chinese leader Deng Xiaoping, quasi-capitalism was embraced, and since then tech companies such as Alibaba and Tencent, along with many other business ventures, have developed.