International Investment Rules
International investment rules require the same respect for diversification, margin of safety and money management that domestic investment requires. However, the regulatory framework, the differences in accounting rules and the thin foreign markets makes increased scrutiny of investing rules a mandatory exercise. International investing rules are the same the world over, however execution is much more difficult outside the United States, Canada and Europe. There are increasingly new financial instruments, including exchange-traded funds, U.S. depository receipts and mutual funds that can expedite foreign investment.
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Differnces Among Countries Create Important Decision-Making Rules
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The most immediate problems with investing outside the United States is lax regulation, thin markets (markets that can bid and offer only a few shares) and lack of diversification. If you are an individual investing in these countries, these problems are further magnified because you will probably have to buy stock through a U.S. broker who must then purchase stock through a local broker in another market. The result is high mark-ups when buying and selling stock and forcing the individual to be long-term holders of the stock.
Trading in Foreign Markets
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Lax regulation often results in inferior financial reports that often do not reflect the actual health of the company nor the possibility of insider dealing. These are problems more associated with emerging company stock and debt issues where the regulatory structure is not uniformly upheld. However, it is not unusual, especially with Asian stocks, to see limits placed on foreign buyers of stock. There has been trends for the issuance of a stock for business and another, non-voting, class B stock for foreigners that tracks the underlying stock and trades separately. The result is that the class B stock may have full disclosure. However, class B is a shell stock that is only a trading vehicle for stock A. It may reveal little of the business activities of the class A stock.
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Rulemaking Varies By Country
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Compounding the problem with foreign markets is that the market makers are often not well-capitalized. This reflects the regulation in each country and the relative wealth of the country. There is little ability for a major institution to buy adequate amounts of stock or find ready buyers of stock for sale. Often these same exchanges trade a few number of stocks. These regulatory controls make diversification difficult and at times impossible. For individuals going through a domestic and foreign broker, it is recommended that you buy an appropriate mutual fund specializing in equities and debt in the countries in which you seek to invest.
Follow Investment Rules and Diversify Risk
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The only real international trading rules are the rules that should be followed whenever making investments in any country. These are the rules for successful trading. Money management, or deciding what percentage of investment funds should be placed on any one stock, is paramount. Unless the investor is a sophisticated institution, it is unwise to make large bets on individual stocks. Enforcing protective stops is also difficult because the spread between the bid and asked price can often be 10 percent or more of the typical amount of risk an individual will risk on a stock. Executions can be spotty, and in some countries market makers might offer a quote for a minimal number of shares. Larger amounts of traded stock have to be negotiated off the exchange.
The Use of the ADR and Other Proxies
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American depository receipts, or ADRs, represent foreign shares that can be traded on U.S. exchanges. Foreign companies must meet U.S. regulatory rules for listing on an exchange. Understand that currency risk is absorbed by the ADR owner. The investor loses money if the stock goes up but the exchange rate of the country where the ADR is based goes down. Exchange-traded funds are passive investments and represent indexes on foreign markets and thus diversify risk. Mutual funds are actively managed funds that employ their management expertise in buying stocks and keeping abreast of foreign rule-making requirements. In addition, they also practice sound money-market measures of risk. For most investors, a professionally managed portfolio offers superior diversified performance to that of individual foreign stock purchases.
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