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How to Invest Internationally From the U.S.

NEW YORK ( TheStreet) -- With the emergence of capitalism in China and explosive economic expansion in Latin America (to name just a few growing markets), if you only invest within the United States, you will limit your investment portfolio to only a small percentage of the global asset class of equities. However, international investing is for neither the faint of heart nor the inexperienced investor.

When it comes to global equity plays, there are several things that must be understood before making your first trade.

Please note: The following is based on several years of equities work in Tokyo, Hong Kong and London, followed by ten years at Merrill Lynch managing the company's equity swap business.

Four Things to Consider Before You Invest Internationally

1. Local knowledge matters: To best understand the culture, customs, current events, fads and politics of a nation, you need to physically be in the country. Being local will provide the ultimate environment for research and better timing for investing.

2. No two markets are alike: Different countries' markets command different multiples, and investor demand varies. Here are some reasons for this:

  • Monetary and fiscal policy will vary from country to country.
  • Yield curves vary as well.
  • Investment activity is influenced by different groups. For example, in some countries, pension plans play a far greater role in the markets. In other countries, individual investors are a more prominent force.
  • The stage of economic growth (whether the economy is emerging, expanding, mature or contracting) affects the country's growth and risk outlook. (See "Emerging Markets Are Not a Monolith".)

3. Companies vary -- even within the same industry: An American retailer may be quite different from, say, a Japanese retailer. If you don't believe that, then compare the shopping experience at Macy's (M) with that at Mitsukoshi.

4. The impact of foreign exchange (FOREX): When you invest overseas you are investing in two assets: the underlying asset stock or bond and the country's currency. The changing relationship between countries' currencies will have an impact on direct investing in a foreign security. I will discuss this in greater detail a little later in this article.

Other factors to consider when investing internationally include the global differences in accounting and taxes.

Three Ways to Invest Internationally

Here are three effective ways to invest internationally from within the United States.

1. Country-specific or regional funds:

Through Internet-based "long distance" research, it is far easier to gauge how the broad market will fare in (for example) South Korea or Italy than to do so for individual companies like South Korea-based Samsung or Italy-based UniCredito Italiano.

Most countries have a benchmark index like the Nikkei 225 in Japan or the DAX in Germany. In addition, many international investors will use the MSCI set of international indices as guideposts for foreign investing.

Once you decide on a country or region to invest in, there are two effective ways to play country funds: exchange-traded funds (ETFs) or closed-end mutual funds.

This strategy of understanding and investing in an entire country's or region's economy, market or foreign exchange is a less complex and less risky endeavor than taking a more precise position in an individual foreign company.

Markets I like, and why:

I like Hong Kong and China due to the emergence of capitalism and expansion of infrastructure; Israel as a hotbed for technology and biotechnology; Australia for its overall strong growth, currency and mining industry; South Korea for its tech growth; and Mexico and Brazil for their key roles in expanding Latin American economies.

To get exposure to a few of these countries, I own country-specific funds such as First Israel Fund (ISL), iShares Brazil (EWZ) and iShares South Korea (EWY).

When you identify the country or region that you find investment-worthy, remember to research (as always) a few fund "product names" before picking one. As "Busting the Mutual Fund Myth" shows, not all funds are alike.

2. Foreign-based companies:

Given the earlier list of considerations, if you are comfortable investing in individual foreign-based companies, you need to understand how the markets for international stocks work.

Foreign stocks are traded on the home-country exchange and referred to as ordinary shares. Ordinary shares are denominated in the home-country currency. Many foreign companies will list their stocks in the United States in securities called American Depository Receipts (ADRs).

Here is the catch: there is a formula to convert the price of ordinary shares into that of ADRs. Here it is:

ADR Share Price = Ordinary Share Price (x) Conversion Ratio of Ordinary Share Price to ADR Shares (x) Foreign Currency Exchange Rate

Here is an example:

The price of BHP Billiton (BHP.AX) ordinary shares is AUD (Australian Dollars) 43.10 (1 AUD = 0.875 U.S. Dollars).

There are two ordinary shares for every ADR.

Thus, the theoretical price of the BHP Billiton ADR (BHP) equals:

43.10 x 2 x .875 = $75.43

As you can see the risk in investing in ADRs is multivariate.

Also, sometimes there are natural spreads between the ADR and its theoretical price. This is due to supply/demand conditions, conversion fees, arbitrage activity and taxes.

All of this adds to the complexity of investing in individual foreign companies.

Given my background and experience, I am comfortable holding ADRs. A few I own include China Life (LFC), the largest insurance company in the largest country, China Mobil (CHL), the largest mobile carrier in the largest country and Australia-based BHP Billiton, a major global commodities player.

3. U.S. multinational companies:

There is a multitude of American companies that have huge revenue and cash-flow generation from overseas operations. Take for example a company like McDonald's (MCD), which I own. McDonald's has roughly 50% of its revenues sourced from international markets.

A company's international business information can easily be obtained in its quarterly earnings releases and annual reports or earnings conference calls. In addition, some companies provide easy-to-read fact sheets or "tear sheets" with operating information on their Web site (look for the "Investor Relations" section).

In addition to McDonald's, my multinational holdings include stocks such as Freeport-McMoRan (FCX) and Google (GOOG), both of which have significant international revenue sources.

At the time of publication, Rothbort was long LFC, CHL, BHP, EWZ, EWY, MCD, FCX, GOOG, and long stock and calls for MER, although positions can change at any time.

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