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Mutual Fund News

A global garage sale, but not without risks

A move to the international scene can land some bargains - or spark buyer's remorse

Special to The Globe and Mail

When it comes to buying securities, the whole world is on sale. Heavily discounted prices are everywhere following the great market slaughter of 2008, and for the self-directed investor, it might be an ideal time to go bargain hunting.

Increasing your exposure to global stocks, bonds and other securities can be done easily these days through online discount brokerages. But it's often not for the faint of heart. Investing overseas can carry a lot more risk than staying closer to home. Impulse shoppers beware: An excursion into international investing can easily lead to buyer's remorse.

To help minimize volatility, mutual funds or exchange-traded funds that hold a diversified range of investments are often the preferred access point into global markets.

Online brokerages have many to choose from. Some invest in the developed regions of Europe and Japan, while others hold securities in the emerging markets that encompass pretty much everywhere else.

Emerging markets

Emerging markets can be particularly dicey. For that reason, Bob Gorman, chief portfolio strategist for TD Waterhouse in Toronto, suggests investors find a fund that holds a broad range of securities throughout Asia and Latin America.

"That will give you diversification across regions and industries, and that to me is generally the best option," Mr. Gorman says.

His preference after that would be to invest in a regional fund - one that focuses on Latin America or Asia, and ensures risk is at least spread among the countries that make up the region. If it's a mutual fund, the portfolio manager will have the ability to reduce holdings in countries that seem hazardous because of political instability.

Country-specific funds

Some may also want to consider country-specific funds. While certainly not ideal as a core portfolio holding, they will at least provide the diversification of holding numerous securities within one country.

Mr. Gorman suggests do-it-yourselfers refrain from investing in individual securities, unless they know the company and country thoroughly. Often in emerging markets, such as China, corporate governance issues pose considerable risk, and accounting standards may be lax.

"The less diversified you get, the more you subject yourself to political risk, security selection risk, issues relating to ethics, and so on," notes Mr. Gorman.

Mutual funds and exchange-traded funds have their pros and cons.

Investors seeking international exposure to stocks and bonds may feel more comfortable buying mutual funds that are actively managed by a professional. That may help control risks and could see the fund outperform the exchange-traded products that usually simply mirror various indexes.

But in most cases you'll pay more for actively managed funds through higher management expense ratios (MERs). ETFs also tend to be more tax efficient: Mimicking an index usually means little turnover of stocks and less triggering of capital gains.

Exchange traded funds

The number of ETFs focused on international markets has expanded rapidly, Mr. Gorman notes, with many now focused on niche markets as opposed to broad indexes. Canadians can buy U.S.-listed ETFs but must stick to domestic mutual funds when investing abroad.

Self-directed investors are subject to brokerage transaction fees when buying or selling ETFs. That might be an important factor to consider, because holders of globally focused ETFs may be wise to more actively manage their portfolio than those who gain exposure solely through mutual funds.

"I truly believe that if someone is doing ETFs, they are going to need to actively manage their ETFs," says Teresa Black Hughes, senior financial planning and investment adviser at Solguard Financial Ltd./PEAK Securities Inc. in Vancouver. "I'm not a big fan of just letting their ETFs do their thing."

That might mean switching funds out of a region that is showing signs of political instability, or keeping a certain portion of an account in cash for future opportunities. A blend of ETFs and mutual funds might be the best way to go, says Ms. Hughes.

Be wary of fees

Internationally focused mutual funds tend to carry higher MERs than those that concentrate in North America, given the extra complications of investing abroad.

But be wary of paying too much. John DeGoey, vice-president with Burgeonvest Securities Ltd. in Toronto and a certified financial planner, says the self-directed investor who wants broad international exposure should consider low-fee mutual funds from direct-to-consumer investment houses such as Beutel Goodman; Phillips, Hager & North, and McLean Budden.

However, investors who want a more country-specific product usually have to purchase an A-Class mutual fund offered from the bigger investment companies.

With these, a self-directed investor still has to pay a trailing commission as part of the MER. Designed to compensate investment advisers for selling the fund and providing ongoing advice, these trailers typically tack on an extra 1 per cent to equity fund costs.

"If you are a self-directed investor, advice in a traditional sense is neither requested nor received, but it is paid for at any rate, and that to me is a travesty," Mr. DeGoey says.

A few online brokers are trying to make amends for this. Questrade last month announced a new program in which investors can pay $29.95 a month and get the trailers rebated. RBC Direct Investing also offers a new D-class of funds that have much-reduced trailers.

To sidestep these fee issues, Mr. DeGoey suggests ETFs are the way to go: "I think ETFs are the most diversified, the lowest cost, and the most tax effective, pretty much any way you slice it."

Buying individual foreign stocks is probably only worthwhile for those investors with seven-digit portfolios, he says. For those who want to go that route, he advises buying stocks that are inter-listed -- trading both on foreign and Canadian exchanges -- to avoid currency risks and other administration complications.

Many online brokers provide guidance on how to put together an international fund portfolio.

For example, at RBC Direct Investing, customers can access model portfolios of mutual funds and ETFs based on investment style and risk tolerance, notes Donna Nelson, vice-president of strategy.

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Another option

Buying shares in an overseas company can be executed by purchasing American depository receipts. An ADR is essentially a stock that trades usually on a major U.S. exchange and represents a specified number of shares in a foreign company. ADRs are issued in the United States by banks or brokerages, and hundreds are available.

"If people want to buy individual international companies, you are generally better off buying them as an ADR than something trading in their home market," says Bob Gorman, chief portfolio strategist for TD Waterhouse in Toronto. Buying actual shares on exchanges overseas -- which isn't offered by many online brokerages -- can often involve extra costs and other complications.

ADRs still pose currency and economic risks. Dividend payments, for instance, could be in euros and first converted into U.S. dollars before you receive them in Canadian funds. There are other drawbacks too, such as reduced liquidity and withholding taxes on dividends.

Darcy Keith

© 2007 The Globe and Mail. All rights reserved.

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