International Investing

A Lesson From My Dog

By REG CROWDER 
Freelance Financial and Investment Writer

The more I thought about it, the more I grasped this simple fact:

American and Canadian middle-income working families absolutely must get a start on international investing, if they are to have any hope of a decent life over the next decade.

Although she didn't know it, my wonderful Labrador Retriever, Kimmie, brought me face-to-face with the urgency of this matter on our walk this morning (as I write this). We headed up the tranquil gravel road that we usually take.

We walked by a pasture and then a field of new corn, about as high as my forehead.

Kimmie suddenly focused on a patch of grass on the edge of the cornfield. In a blinding flash that was literally too fast to see clearly, she yanked an innocent hare from the grass and broke its neck. I hated it. But there was nothing to do. The poor little creature was clearly dead before I knew what happened.

Then Kimmie opened the carcass in a few swift moves.  What took place next amazed me.

Kimmie ran home with the fresh meat in her mouth and presented it intact to my wife, Anne, at the door.

Kimmie, this beautiful, sweet, wonderful dog has never been a feral animal. She has never spent the night outside the house. She wasn't hungry. I had given Kimmie a big meal maybe two hours earlier.

Something triggered a deep-seated instinct for survival in Kimmie.  But her instinct didn't tell her to kill the hare and eat it, keeping it all for herself. No. Kimmie's instinctive drive told her to take the food home to her family.

I figure if Kimmie can "get the concept," so can we.

Investing, a Survival Skill

Our first responsibility is to try to keep our families alive. If we can make them comfortable and happy, so much the better.

(May I add that in my mind, gender has nothing to do with family. Whenever caring people come together to help each other through the joys and sorrows of life, they are a family. The question of whether some government agency has accepted a fee and issued a license conferring its own bureaucratic blessing upon the creation of a family is irrelevant to the point of being ridiculous. Like matter and energy, families are fundamental things that state legislatures can neither create nor destroy.)

But I digress.

For most of us today, survival doesn't depend upon catching animals for food. It depends upon having the money to buy that food.

In the industrialized world, and particularly Canada and the United States, providing sustenance and security to our families means shifting as much of our income from salaried work to investment income as we possibly can. The tax systems of both countries favor passive, investment income over salaried income to such extremes that there is no point in resisting.

Those Dead-End Paychecks

If we are to have any hope of achieving financial security, we must find a way to get income through some mechanism other than a paycheck. To do that, we have to find a way to do a little investing. I agree that's easier said than done. Don't worry. Now and then we're going to talk about how to make it easier.

That brings me to international investment for Americans and Canadians. (I'm both, by the way. I'm a dual national with both Canadian and American citizenship. I am intimately acquainted with the economies of the United States and Canada. More important, I have hands-on, real-world experience with the capital markets of both countries.)

I'm going make two points about international investing. The first point is one you've probably heard too many times already. The national and regional economies outside Canada and the United States are growing a lot faster than Canada and the United States.

Invest in Growth, Not Stagnation

In short, if you make thoughtful and careful investments in rapidly growing economies, all things being equal (they aren't), you're going to make money faster than if you make the same kinds of investments in slowly growing, stagnant or declining economies.

I already hear you saying, "It doesn't take a rocket scientist to figure that out." You're right about that.  And yet, a lot of individual investors never get that far. They invest in their own national economy and never go beyond it. And by doing that, they voluntarily walk way from profits that they could have had without taking on any additional risk.

The second point is at least as important:

International investing offers "tools" that open the door to investing that makes sense for middle-income working families and how they really live.

Advice Nobody Can Afford to Follow

One of the first things you are going to hear (except from me) when you get serious about investing is something like this:

Don't touch the money once you've invested it.  Don't sell stock to fix your roof. Don't unload any of your ETFs ("exchange traded funds") to get your car repaired and back on the road. Don't liquidate any of your mutual fund shares to pay your child's medical bills.

(Canadians don't have to worry about this last one, yet. But as one who has experienced the soul-destroying cruelty of the US health care system, the words alone are enough to give me a dry mouth and abdominal pains.)

Are You Out of Your Bloody Mind?

Those are crazy, irresponsible things to tell people.

Personally, that's where my brain shuts down.

We working people can't live that way. When some self-important clown pontificates to me about how I can't ever touch my investments because I'll never get anywhere if I do, I instinctively tune out.

If I don't fix the roof, the house disintegrates. If the car doesn't run, I can't get to work. And so on.

Fortunately, telling us that we can't ever touch our investments to meet urgent day-to-day needs is pretty much a lie.  Not completely. It is about 20% true and 80% false.

Yes, if you sell investments at a loss, it becomes more difficult to get ahead over time. But if you could sell a portion of your investments at a profit to deal with an emergency - and leave the balance untouched - the consequences aren't so bad.

International investing opens the door to doing exactly that.

All of the world's economies go through cycles.  But they don't play out in exactly the same way. And they aren't synchronized.

At any given moment, there are several economies in the world that are at or near the bottoms of their economic cycles. And at the same time there are several economies in the world that are at or near the peaks of their economic cycles.

Not 'Trapped' in Your Investments

If you have investments a different national economies that go through their internal business cycles at different times, you will usually have the opportunity to sell some of them at a profit - if you need the money to satisfy an urgent need.

There you have it.

International investing opens the door to a strategy that makes sense for middle-income working families in the United States and Canada.

You don't have to promise yourself that you're never going to touch your investments, when you know damn well that now and then you probably won't any any alternative.

I can already sense an army of self-appointed experts preparing to attack this premise. They will tell you that the world economies are "so highly correlated" that what I say is impossible. In due course I will blow them out of the water with facts. You don't have to believe a word I say. I will simply point out the facts now and then and invite you to decide whether I'm on the right track.  I will put my biases and opinions on the top of the table where you can see them.

'Convergence' Nonsense Buried

This fantasy that the world's economic markets somehow homogenized themselves into a uniform viscous substance through "global economic convergence" is so destructive of sensible investment that it deserves a little more attention - right now. This nonsense is damaging the lives of a lot of good people. And it could really take a piece out of your quality of life, too.

The newest, freshest, cutting-edge data on the fairy tale of global convergence is contained in International Monetary Fund (IMF) Working Paper No. WP/08/143  written by M. Ayhan Kose, Christopher Otrock and Eswar Prasad.  The title is "Global Business Cycles: Convergence or Decoupling?"

In a nutshell, "decoupling" is the big story. The authors concluded:

Our main result is that, during the period of globalization (1985-2005), there was some convergence of business cycle fluctuations among the group of industrial economies and among the group of emerging market economies. Surprisingly, there has been some concomitant decline in the relative importance of the global factor. In other words, there is evidence of business cycle convergence within each of these two groups of countries but divergence (or decoupling) between them.

If you click on the paper's title (above, or on the blue link to the right), a link  takes you to a summary page on the IMF website. The page also has a link that will allow you download the entire 50-page document as a PDF file at no charge. Nothing would make the IMF happier than to learn that hundreds of thousands of individual investors - better yet,  millions - had downloaded the paper and used it to help guide their future investments.

About now, you should be wondering why you had to come to me to hear this.  As usual, it has something to do with money.

Hedge Fund Flunkies

Hedge funds are a part of it. Without getting terribly technical about it, hedge funds are allowed to skip a lot of the securities regulations by limiting investment to institutions and "high net worth individuals" (HNWIs). The rationale for this is the belief that these institutions and HNWIs are sophisticated and knowledgeable enough to look out for themselves. Some are and some aren't.

By hiding what they do in a fog of secrecy and mysticism, thousands of hedge fund managers throughout the world are able to reward themselves with six-digit and seven-digit salaries. This is despite the fact that a surprising number of hedge funds turn in performance inferior to the results you would get from taping the newspaper stock pages to a wall, throwing darts at them and buying the stocks that you hit.

This hedge fund manager thing is a great gig. The last thing these guys want is a straightforward, fact-based discussion of what really makes money.

This is how Giles Drury, a senior manager in the Alternative Investments Group of accounting firm KPMG in the UK  explained it to me, for an article in Families in Business Magazine:

"There are about 10,000 hedge funds out there and most of them are pretty mediocre. Genuine talent in investment management is a truly rare commodity."

[Source: "Needling out the best third party advice," Families in Business magazine, No. 36, January/February 2008]

Search Engine Pandering

Another problem for small investors like you and me is what I call "search engine pandering" by the financial media. There is a growing body of evidence to suggest that mainstream media are manipulating their content to maximize search engine placement - rather than to bring new and innovative companies and ideas to the public's attention.

Tim Hanson wrote about this phenomenon in The Motley Fool in an article entitled, "What The Financial Media Don't Want You to Know."

He wrote that the big financial media only cover the biggest companies now because a lot of people own their shares. Hanson said the media giants believe that brings them more online readers. Good for the media. Not so good for the readers. Why?

Hanson pointed out, quite correctly, that over the long term smaller companies make a lot more money for their shareholders than the giants.

Hanson said that largely because of the corporate financial media's excessive emphasis upon the biggest corporations "the stock market - even in this age of unmatched access to information - is a self-perpetuating machine for mediocrity."

I broadly agree with Hanson.  But it isn't a problem for you as an investor once you have a clear idea of what you want to accomplish in your international investing. The information that you need to come out on top in the international markets isn't difficult to find, once you know where to look.

So, this bad news about the financial media is now good news for you and me. If a majority of investors are following the lead of the mainstream financial media like myopic sheep, it becomes much easier for you and me to find the great bargains first.

Okay, fair enough. Where are we looking for these great deals?

Which Countries?

Exactly What Countries?

International investing for Americans and for Canadians are almost the same things - but not quite. Several years ago, a Canadian radio station sponsored a competition to complete this slogan:

"As Canadian as --- "

The winning entry was:

"As Canadian as possible under the circumstances."

Canada and the US are very different countries with very different economies. The Canadian economy is smaller but much healthier than that of the US. Unless you're a Canadian, you're going to have a hard time believing this but it is true: In Canada, the politicians are wringing their hands over the "end of huge budget surpluses." This, while the US budget deficits spiral ever further out of control.

And yet, Canada cannot escape untouched by the US budgetary and trade madness.  In most years, the United States is Canada's biggest customer. If you've ever been in business yourself, you know that when your best
customer is hurting, you are hurting.

For Americans, the way I see it, international investing means considering investment in every country except the United States.

In my view, for Canadians, international investment leaves the door open for investment in every country except Canada and the United States.

The last time I was in Canada for an extended period of time, I was working in Vancouver. I found that investing in the US wasn't a problem.  There was plenty of information about the American capital markets. All of the major brokerages were set up to handle trades involving US investments.

So, if Canadians really want to make investments in the US, they don't really need any help from me.

The situation is quite different in the US, regarding investment opportunities in Canada. Americans have a lot to gain from putting some of their money into Canadian investments. News coverage of Canadian markets in the US is quite limited. There's no in-depth coverage of the Canadian stock exchanges.  Some US brokerages even tell people they aren't allowed to place order for stocks listed on Canadian exchanges.  (They're lying.  In most cases they are just too lazy to bother. This isn't a big problem. You just shop around for a broker who doesn't lie to you.)

I don't see much of a future for Canadians putting money into the United States. But if that's what they want to do, it is quite easy.

But, my dear fellow Canadians, before you toss a single Canadian Loonie into the bottomless pit of the US capital markets, please do one thing for me.  Visit the "Official Home Page" of Berkshire Hathaway Inc.

(By the way, I have no problem with US companies, just the US capital markets. Hungry young US companies that aren't dead from the neck up raise their capital today in London, Toronto, Paris, Geneva, Amsterdam, Frankfurt, Berlin, Brussels, Geneva, Zurich, Guernsey and Jersey. Well managed Asian companies try to go public in Hong Kong or Singapore. Malaysia may pop up on that list soon.)

Berkshire Hathaway's chairman, the legendary Warren E. Buffett, gets a lot of media attention. But only one article from the mainstream financial media is posted on the website of Berkshire Hathaway. It is an article written by Buffett himself that was published in Fortune magazine.

When you arrive at the Berkshire Hathaway home page, look around for a link that looks like this: Fortune Article by Warren E. Buffett Regarding U.S. Trade Deficit, November 10, 2003. Download the article and read it. If, after that, you still want to invest in the United States, well, you've been warned. 

For these reasons, and a few more, as this "knol" article grows, I will propose investment opportunities everywhere in the world except the United States.  (One exception: I will recommend soundly managed and promising foreign companies that trade on public exchanges both in their home countries and in the US. Such companies have a high level of protection from America's self-inflicted economic catastrophes.) American investors will get some help they desperately need to avoid being gutted, pan roasted and eaten like a freshly hooked sea bass. Canadian investors will probably get some information about Canada that they don't need at all.

You're going to need some sort of perspective to guide your investing style. There are several possibilities.

This is where I should, in the interest of transparency, disclose one of my own biases. I believe in the style called "value investing." Boiled down to its essence, value investors strive to buy stocks and other securities that are priced below their true value.

The 'Holy Books' of Value Investing

I keep two books within reach whenever I am researching or writing about financial matters. They are:

• "Security Analysis, The Classic 1934 Edition," by Benjamin Graham and David Dodd, The McGraw Hill Book Company Inc., New York. ISBN: 0-07-024496-0. [Personally, I prefer the 1934 Edition but don't get upset if they have run out and you have to take a newer edition. Just be absolutely certain that Benjamin Graham and David Dodd are the authors. There are a lot of "copy cat" titles out there.]
• "The Intelligent Investor, A Book of Practical Counsel," by Benjamin Graham, HarperBusiness, A Division of HarperCollins Publishers Inc., New York, ISBN: 0-06-015547-7. HarperCollins Publishers Inc. also has a book by Benjamin Graham on how to read financial statements.

You might call these the Holy Books of Value Investing. They don't tell you what to do. They tell you how to think about what to do.

I'm not saying everybody has to fully embrace value investing. I do say without reservation that it is a good place to start.

There are several approaches available to American and Canadian investors who'd like to give international investing a try:

Exchange Traded Funds - ETFs

Exchange Traded Funds (ETFs) are beautiful in their simplicity. You buy ETF shares on one of your national stock exchanges. Each share you buy gives you an interest in a basket of stocks or other securities. Because of the very small commissions and fees, they are tremendously efficient. As a bonus, they generally trigger smaller tax liabilities than most other funds.

One really nice thing about ETFs that nobody seems to be interested in talking about is what happens to ETFs when the financial markets get hit with some sort of panic. If other investors become desperate to get out of their ETFs, they simply sell them on the same market where they bought them. The sponsor isn't required to redeem them.

Some years ago, after the collapse of the Soviet Union, the government of Russia made some tricky moves that amounted to reneging upon its debt. This triggered one of those "bug-eyed, hair on fire panics" among investors in open-ended emerging markets mutual funds that held Russian stocks.

When the panic hit, Russian stocks became untradable.  Investors exercised their right to sell their shares back to the funds. The managers of open-ended emerging market mutual funds had to come up with money to redeem their shares. The funds were forced to sell perfectly wonderful stocks from other emerging markets in order to redeem the shares of the investors who "went postal" over what was happening in Russia.

As everybody knows, Russia came back, big-time. Everybody loves them again. They're the second letter in "BRIC" - the mantra for hot emerging markets.  But a lot of long-term investors who knew this was how it would turn out got their heads handed to them on a plate - because they had invested through open-ended mutual funds. They did everything right but the others investors who did everything wrong took everybody down with them. It would have been quite different with ETFs.

I'm not going to say that anybody escapes entirely unscathed when the world's capital markets go totally bananas. (It will happen from time to time.) But I will say that investors in ETF's are much less vulnerable to having their fund shares permanently trashed by panic-stricken investors than the ones who hold shares in open-ended mutual funds.

ETFs were born primarily as an efficient way to invest in indexes. The good things I have to say apply to index ETFs. A new kind of ETF is in the process of being born at this very moment. They are "actively managed" ETFs. That means the portfolio managers are allowed to change the portfolios as they see fit.  I'm not going to say anything good about actively managed ETFs until I see how they work in the real world.

Today, I just don't know.

Open-End Mutual Funds

So, am I saying nobody should ever buy open-ended mutual funds? Absolutely not.

To review briefly, open-ended mutual funds are funds whose managers are (1.) allowed to change what they own, (2.) can increase and decrease the number of shares in circulation and (3.) are obligated to redeem shares upon demand. Most of the time, the prospectus or other offering document will give you a fairly clear description of the investing style and objectives of the fund. But within those broad guidelines, the fund managers have a lot of flexibility as to just how they go about investing your money.

The one, great vulnerability of an open-ended mutual fund is the one I talked about above:  Getting trapped in a situation in which the fund must sell good investments in order to come up with the cash to redeem shares during a panic.  But a lot of open-ended mutual funds happily invest for years without ever ending up in that kind of a vice.

The great thing about open-ended mutual funds for North American investors is the huge numbers from which to select. There are a lot of companies out there peddling open-end mutual funds and this has created a lot of choice and genuine competition.

And best of all, there are a few fund managers out there who are extremely good at what they do. Several specialized publications that aren't terribly expensive do a pretty good job of measuring, tracking and evaluating their performance. The one you're reading now is free.

The big downside of this investment vehicle hits you in the face when you look at the expenses. The fees and charges, as a rule, are the highest of all the fund types. There are some exceptions, however. Faced with competition from ETFs, some fund sponsors have sharpened their pencils and found ways to give investors a better deal. Some fund companies now offer both open-ended mutual funds and ETFs.

Closed-End Mutual Funds

In all fairness, I should curb my enthusiasm for closed-end mutual funds right now. To me, researching closed-end funds is sort of like prospecting for gold as a hobby. It is fun to begin with and if you do a little research and pay attention to what you're doing, you will, in fact, find some gold. And you may find quite a lot of it. But then again, maybe not a huge amount. But you'll almost always turn up some gold.

Closed-end mutual funds normally sell all of their shares in an initial public offering (IPO) and use the money to buy a portfolio of stocks and other securities. After that, the selling of the closed-end fund's shares stops. There aren't any more of them to sell. When the IPO has closed, the shares trade on a recognized secondary market such as the New York Stock Exchange, Nasdaq, the Toronto Stock Exchange or the American Stock Exchange.

The sponsor of a closed-end fund doesn't have to redeem the shares.  If somebody doesn't want their shares, they just sell them on a stock exchange. The fund doesn't face the risk of being forced to sell good investments because investors are in a panic about something in the portfolio that is going down the tubes.

As you can see, closed-end mutual funds have a few things in common with ETFs. You might say that the closed-end funds are the spiritual ancestors of ETFs.

There are a few other differences between closed-end funds, open-end funds and ETFs. Closed-end funds are allowed to borrow money to buy securities.  They have greater flexibility than open-end funds to invest in "illiquid" securities.  In this case an illiquid security is one that can't be sold within seven days at approximately the value the fund used to determine the NAV (net asset value) of the fund.

What does this mean? Just as an extreme example, if you wanted to sell the biggest natural gas field in Colombia, you might make a bloody fortune by doing it, but you couldn't do it in seven days. Illiquidity doesn't tell you what anything is worth. It just tells you that it is going to take some time to sell it, if that's what you want to do.

The great thing about closed-end funds is the fact that the mainstream financial media, the investment banks and the brokers lose interest in them a few months after the IPO. Some critics wring their hands about this. I say, "Hey, no problem. Now the rest of us peasants get to make a little money."

After a while, some closed-end mutual funds are so universally forgotten that they trade on the stock exchanges at substantial discounts to their NAV.  The NAV is what the securities in the portfolio of the fund are, in fact, worth. When this happens, the funds are said to be "trading at a discount."

Pay attention. This is important.

I mean what I said. If you do your research, once in a while you will find a fund whose shares can be bought for significantly less than what the assets they own are worth. I call it "free money on a stick."

Why don't "they" tell us these things? I don't know. I don't care. I'm telling you now: "Free money on a stick."

Foreign Shares on Our Local Exchanges

A lot of wonderful foreign companies trade on US and Canadian exchanges, either as fully "listed" shares or as American Depository Receipts (ADRs). In the real world, it doesn't make a whole lot of difference to the individual investor whether the company is fully listed or traded as an ADR.

Comparing listed shares with ADRs, it might be fair to say the companies with listed shares give you a little more information about themselves than the ones trading as ADRs. But once you get the hang of international investing - and accept the fact that it can be a barrel of fun - you won't have any trouble at all filling in the blanks for yourself.

My sentimental favorite among foreign companies listed on US exchanges, in this case on the New York Stock Exchange, now part of NYSE Euronext, is the Brazilian national oil company Petrobras which is the more convenient, shortened name of Petroleo Brasileiro SA (NYSE: PBR).

Petroleo Brasileiro SA is doing great, both in terms of profitability and share price. They strike me as the model for the successful and responsible integrated oil company for the 21st Century. For a variety of reasons, Petrobras, its US operating subsidiary Petrobras America Inc. and a few other non-US and non-British oil companies are attracting all the best geologists, engineers, economists and energy sector managers in the world.

Petrobras has enough proven oil reserves to support its production for another 14 years.  And it is finding new oil faster than anybody else in the world.  All of the Petrobras oil comes from outside the Middle East, a big plus in my mind.

The closest competitors are ExxonMobil and ChevronTexaco, each with about 11 years worth of oil. Following behind them are BP with maybe 10-1/2 years of oil and Royal Dutch Shell with just under seven years worth of oil.

That's another good reason to think about international investing. If you want to invest in the oil companies of the future, don't waste your time and money on the big names of the past.

Disclosure note: I have held Petrobras shares in the past and will probably own some in the future. I don't own any now.  Some time ago I liquidated my oil positions, anticipating that the oil bubble will recede a bit and then change shape, mutating into two increasingly distinct groups of integrated oil companies. I don't beat myself up about getting out of profitable investments early. I'm great at strategy but pretty awful at market timing. So, I adopt an investing style that doesn't require market timing.

Foreign Shares on Foreign Exchanges

Investing in foreign shares that trade on foreign exchanges takes more time and effort than the other alternatives I have mentioned. However, once you start shopping the whole world, the opportunities to buy shares at deep discounts to what they are really worth increase exponentially.

Finding and evaluating these foreign-traded companies calls for some resourcefulness and a healthy curiosity.  Beyond that, dealing with brokers will be a bit tiresome until you find one who is ready to "play ball" with you. Some brokers will tell you that you aren't allowed to buy shares on foreign exchanges.  That's a lie.

Some discount brokers will tell you that they don't have the means to process your order for a stock listed on a foreign exchange. That's a lie, too. Most likely the person you're talking to doesn't know how to do it.  Or just doesn't want to be bothered. Again, don't worry about it. The world is full of hungry brokers who are willing to do their jobs to earn a living. You just have to find them.

If you let your broker push you around, you are road kill. You're dead meat. Accept the fact that you must always be prepared to whip your broker into shape, if nothing else works.

Keep in mind that is perfectly legal for Americans to have brokerage accounts outside America and for Canadians to have brokerage accounts outside Canada. I kept a brokerage account in the Cayman Islands long before I bade a fond farewell to North America. It had nothing to do with dodging anybody's taxes. I was just disgusted with the breathtaking incompetence of the financial institutions with whom I had done business in the United States and Canada.

(For the record, anybody who breaks a law to reduce his taxes is an idiot. There's no need. Never do outside the law what you can just as well within the law.)

Just as troublesome as brokers who tell you they can't handle foreign stocks are those brokers who will handle the order but burn you with ridiculous fees and markups. You will need to spend some time finding the right broker and keeping him in line. It can be done.

I'll Be Back With More

This is not the grand strategy for your War For Financial Security Through International Investing. It isn't a battle plan. It doesn't even constitute a briefing on the rules of engagement.

This is a call to arms. Nothing more. I want to interest you in trying out international investing. You have quite a lot here to digest. There's no rush.  All I ask is that you begin to think about it.

I will be back with specifics as to where to go from here.

"REG CROWDER" is the author of this article. This work is licensed for publication under the Creative Commons Attribution 3.0 License. ("Some Rights Reserved") If you wish to republish this article, you must clearly attribute it to the author, Reg Crowder, and include a notice of the Creative Commons, Attribution 3.0 License. The "Moral Rights" of the author have been asserted.


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