Knowledge |Risk Management

2nd December 2021

Managing risk when choosing to invest overseas

When investing in overseas markets, it’s important to understand the context of any potential investment opportunity in order to manage risk.

When investing in overseas markets, it’s important to understand the context of any potential investment opportunity in order to manage risk.Overseas investments bring with them potential differences in customs, currency, language and accounting techniques. For the best chances of success – i.e. protected, profitable investments – prior research and due diligence are key, especially into the regulations of any foreign country you wish to trade in.

There are 3 main risk areas that investors should take heed of when investing internationally:

  1. Higher transaction costs
  2. Currency volatility
  3. Liquidity risks.

There tend to be higher expenses on foreign transactions, alongside differing exchange rates or additional charges specific to the market, such as clearing fees, taxes or stamp duties. Added transaction costs vary depending on which international market you are investing in.

Exchanging your money could also impact your return, depending on the time of exchange and the currency you exchange to. Using an exchange-traded fund (EFT) could be a way around this, due to better liquidity and accessibility.

However, liquidity risk poses the potential of losses, if investments aren’t sold at a certain time. There is higher risk of this in foreign markets, especially as it’s harder for investors to protect their capital against losses that occur in a different country with different rules. Arguably, foreign investments are worth the risk, as they contribute to a well-balanced portfolio that utilises the global economy.

Avoiding risk in overseas investments

There are products and techniques that can be used to ensure your international investments are better protected. These include:

  • Global depository receipts (GDRs) can be traded, cleared and settled like domestic stocks are, by institutional or private investors. They can be found on the London Stock Exchange.
  • Foreign direct investing via a domestic-based broker, or a broker based in the target country, that can buy foreign stocks directly on your behalf.
  • Global Mutual Funds – Mutual funds use international equities that can be regional or country-specific. They can be sourced in a passive index fund or a managed fund, which means there are higher fees involved.
  • Exchange-traded funds (ETFs) offer investors access into foreign markets, rather than having to compile a portfolio yourself. ETFs provide insight into multiple international markets.
  • Multinational corporations (MNCs) – Investing in MNCs gives investors international exposure without having to directly invest in foreign stocks.

How do I manage the risk of investing overseas?

It is vitally important for anyone considering investing in overseas investments to either do extensive research on the country and the type of investment before committing, or, as an extra type of safety net, invest through reputable investment vehicles such as Global Mutual Funds, exchange-traded funds or global depository receipts.

As the global economy is still navigating it’s way through it’s most volatile period, it’s important to take the time to do your investment homework.

The first step for an investor is to conduct a country analysis, deciding where exactly to invest. Investing in a broad international portfolio is best, or within a specific region or set of countries, rather than in a single foreign country. Diversification is important when investing internationally, as maximising diversification minimises risk.

Once the country or countries of investment are decided, the investor must decide which investment vehicles to invest in, for instance in stocks or bonds of companies within the country, mutual funds, internationally focused ETFs, etc. Ongoing monitoring of the investment portfolio needs to be done, as the economic conditions overseas will be continuously changing.

The political and economic landscape of the investment country must also be observed, as any abrupt changes can result in unexpected losses to investments. This is part of the country risk analysis, as countries with stable finances and a strong economy offer safer investments than those without. Countries that are unfriendly towards foreign investors or that are in political unrest also offer a less stable investment opportunity.

The Economist Intelligence Unit (EIU) offers comprehensive and objective information on different countries, including an overview of the political, social, economic and demographic climate. Other country risk analysis resources which can help investors include the CIA World Factbook and the UK government’s Overseas Business Risk service.

At ESA Risk, we offer enhanced due diligence services, which can help you see the whole picture before committing to an investment. Contact us for an initial chat with our experienced consultants. You can contact Ali Twidale, Banking & Financial Fraud Consultant at ali.twidale@esarisk.com, on +44 (0)843 515 8686 or via our contact form.

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