ORIENT: Global Inroads To Value and Diversification

Global Inroads To Value And Diversification
by Andrea Drake

Q: Why invest globally at all, Ms. Drake? Exactly what can global investing do for one's portfolio?
By allocating a percentage of your investments globally, you can benefit from the potential offered by the world markets and add a level of diversification to your portfolio. Diversification tends to reduce the volatility of your portfolio. Since the cycles that drive enterprise and investment occur in different countries at different times, foreign markets seldom move in line with each other or with those in the United States, so losses in one market may be offset by gains in another.
In fact, a study of world markets cited by The New York Times showed that diversification into overseas markets over a 10-year period not only reduced portfolio volatility, but also increased returns. The study revealed that the least volatile portfolio would have contained 30% foreign stocks and 70% U.S. stocks. Although there is no guarantee that this performance will continue, it's one of the more compelling reasons why increasing numbers of investors are looking abroad for investment opportunities.
Q: Exactly what are we talking about when we refer to the "potential"İof world markets?
For example, the countries of Latin America, Asia and the Pacific Rim benefit from a highly-skilled, hard-working, low-cost labor force. They have an abundance of natural resources and a high personal savings rate, which have translated into ready sources of cash for ongoing investments. China's apparent turn toward capitalism in its free economic zones figures prominently in attracting investors from our country.
In Europe, the union of 12 countries now encompasses 350 million consumers. This new market is expected to create many opportunities for existing companies in Europe as impediments to trade are dramatically reduced. At the same time, investors should benefit from opportunities in both Eastern and Western Europe, as governments step up efforts to privatize state-owned companies.
Q: With literally hundreds of foreign stocks available, how would an American investor track a foreign security?
One of the most convenient ways for U.S. investors to participate in overseas stock markets is through American Depositary Receipts, or ADRs. ADRs are registered U.S. securities representing ownership in a foreign company's shares. They can be bought and sold on U.S. exchanges just like U.S. stocks. As a result, they eliminate the complexities caused by different time zones, languages and currencies. ADRs are available for hundreds of companies from numerous countries. Many of the foreign shares that have changed hands in America have been bought and sold in the form of ADRs. In 1993, for example, 6.3 billion ADRs were traded.
Q: How are ADRs bought and sold?
ADRs can be bought and sold just like stocks in U.S. companies. Their prices are quoted in dollars, they trade in dollars and their dividends are paid in dollars. Many are listed on U.S. stock exchanges and their prices appear regularly in financial newspapers.
Q: Does it take a long time for ADR trades to settle?
ADR trades clear and settle just as easily as U.S. stock trades, typically within five business days.
Q: Does the investor have to calculate exchange rates in these transactions?
As an ADR investor, you avoid some of the costs and inconvenience associated with foreign exchange transactions. However, one should know that ADR prices are directly affected by currency fluctuations as well as by other economic and/or political risks specific to the issuing country. Since they represent a fixed number of the underlying foreign shares in U.S. dollars, ADRs may perform better or worse than the underlying shares in the home market. In general, if the U.S. dollar rises in value vis-a-vis the ADR home country currency, performance will drop; if the dollar declines, performance will improve.
Q: Are there any long-term investment vehicles which are proving to be popular with American global investors?
As a matter of fact, yes. Over the past decade, the variable annuity has become increasingly popular particularly among investors saving for retirement. In 1986, industry sales were estimated at $3.6 billion. In 1993, this figure grew to an estimated $43.1 billion according to Tillinghast/ Towers Perrin. The variable annuity is one vehicle developed by insurance companies and financial managers to help investors benefit maximally from global investment. It combines diversification, investment potential, flexibility and tax advantages in a single investment.
Q: Explain further the flexibility feature of variable annuities.
First of all, many variable annuities offer a wide variety of investment options such as stock, bond and balanced portfolios. Depending upon the investor's risk tolerance and financial objectives, investments can be made in domestic, global or international portfolios whose objectives include growth, income, or growth and income. What's more, if the investor's objectives change at any time, he or she can transfer between the portfolios free of current taxes. This enables the investor to make decisions based on the investment objectives rather than on current tax consequences.
Q: Is that freedom from immediate taxation primarily what attracts long-term investors to variable annuities?
Yes. The tax-deferred growth feature of variable annuities maximizes long-term growth. And, while earnings are taxable upon withdrawal and/or subject to a 10% tax penalty if withdrawn before the age of 59-1/2, any interest earnings, dividends and capital gains are automatically reinvested into the variable annuity, without current tax. This can help generate additional earnings at a time when many Americans face an increase in their personal income tax rates. It is also advantageous for individuals who receive Social Security benefits because tax-deferred earnings are not used in the calculation to determine taxes due on Social Security benefits until they are withdrawn. As always, however, I do urge one to consult his or her tax advisor before pursuing any tax-related investment strategy.
Q: We've talked about the advantages of global investment. What about risks?
Always bear in mind that in exchange for their greater growth potential, investment in foreign securities can have added risks, including changes in currency rates and economic and monetary policies, differences in taxation and auditing standards, and risks related to political and economic developments. Working together with a good financial advisor should, however, minimize those risks and define which foreign investments will be most suitable for one's portfolio.
Andrea Drake is Associate Vice President for Investments at Dean Witter Reynolds, Inc. in Orlando, Florida. She can be reached locally at (407)849-4753, or nationwide at (800) 869-0007, for further consultation.

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