How Do I Choose Countries to Invest In?
When you think about what countries to invest in, the first thing you should be thinking about is risk. Countries are all different in terms of how risky it is to invest in them. So before you pick a country you should make sure that it matches the same level of risk you are willing to take on your portfolio.
The best way to start your research is to divide countries into developed and emerging markets. Developed markets, such as the U.S., Canada, UK and much of Europe, Japan and Australia are seen as less risky. Emerging markets, such as countries in Africa and Latin America, India and China are seen as more risky. Take a look at the map below. The darker blue countries are the most developed and the gradient gets lighter the less developed the country is.
But what’s the difference between the two and what can I expect if I invest in them?
Developed markets are already highly-industrialised with well-conditioned economic and political infrastructure in place. As a result, growth rates are lower than their emerging counterparts, but the risk of market collapses and political upheaval are much lower, making them more stable.
Developed markets will often produce highly-skilled products, such as technology, aerospace and automobiles, and generally have more advanced services sectors, such as financial and healthcare. They also offer better protection from an investment standpoint, with more robust regulatory structures in place to shield investors from market collapses and unforeseen events.
Emerging markets are less industrialised by comparison, and often have weaker political structures and less-established economic & regulatory systems. Emerging markets will often have higher growth rates as there are more opportunities to exploit gaps and control new sectors of the market. But the risks of political instability are much higher. I’m sure you’ve heard of the saying, ‘high risk, high reward’. Well, that’s the basic principle here!
Emerging markets, in general, produce more basic products, such as raw materials, commodities, agriculture and textiles. These products will ultimately drive the direction of these countries’ economies and have the biggest effect on their performance.
So when you’re building your portfolio it’s important to know where you are investing your money and how much risk you are taking on by investing in foreign or local companies. By investing in copper, for example, you are exposing yourself to risk from The Congo which is the one of the largest producers of copper in the world. A collapsed mine or political event that affects the supply of copper coming out of the Congo could easily send the price through the roof or crashing down in seconds.
Holding too many investments from one country makes your portfolio very vulnerable to the problems of that country. If you spread your investments across multiple countries, a problem that sends one country into a downward spiral may not affect the rest of your portfolio. We call this diversification, and it is an incredibly important tool for risk management. This pie chart is a good example of a diversified portfolio containing both emerging and developed market assets.
Choosing countries that are growing is a good way to find lots of good investments. When a country grows it means that the majority of the businesses that make up the economy are growing and performing well too, giving you more opportunities to find solid investments. Some important measures for performance are:
Real Gross Domestic Product growth (GDP): improvements every year are indicative of a growing, prosperous country.
Inflation: stable inflation makes sure prices are not changing at an unmanageable rate.
Unemployment: relatively low levels of unemployment is a good sign of an expanding country, but too much employment causes wage inflation and too little causes a drop-off in consumption — so look for countries in a happy middle-ground.
Current account: countries with positive current account balances are seen as more stable as they are net lenders to the rest of the world. Countries with a current account deficit are considered more risky as they are net debtors. Countries with large deficits often suffer from volatile currencies which affects their international business if their prices change too rapidly.
So, now you have the basics, here’s how you can get involved in alternative markets.
ETF’s and ADR’s offer great solutions to gaining exposure to foreign markets in a safer, more familiar way. For investors in the US, American Depository Receipts (ADR) allow them to trade shares of foreign companies like any US security, and avoid the hassle of constantly converting to foreign currency whilst operating at far lower transaction costs than investing directly in a company’s shares. Exchange Traded Funds (ETF) also allow investors to invest in a basket of stocks from a certain country to benefit from its overall performance without having to spend hours choosing individual stocks.
The key take-aways are:
- Understand country risk and use it to your advantage
- Have a diversified portfolio to protect you against problems in a single country
- Keep track of the four key economic indicators
- ADR’s and ETF’s are excellent instruments for getting foreign exposure in a familiar format for
Related: Mad Moments In Financial History