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Why investing abroad can be a good idea

Posted On 1/8/2018

InvestmentThe trend toward investing abroad has been gaining popularity since the 1990s. Companies choose to invest in foreign markets for a number of reasons:

Market seeking

Firms may go overseas to find new buyers for their goods and services. The top executives or owners of a company may realise that their product is unique or superior to the competition in foreign markets and seek to take advantage of this opportunity.

Another motivation for market-seeking occurs when producers have saturated sales in their home market, or when they believe investments overseas will bring higher returns than additional investments at home. This is often the case with high technology goods.

Capitalisation of Emerging Markets

Large companies often invest abroad when they see an opportunity to capitalise. This sort of investing has increased in popularity in countries that are experiencing tremendous growth (“emerging markets”). Emerging markets receive welcome investments from abroad, which helps to accelerate their growth.

Portfolio Diversification

Money managers often balance portfolios by investing abroad. For example, when a company operates globally as well as domestically, buying that company’s stock exposes you to possible profits in multiple countries. Investing in a company that operates in multiple countries may also be safer, since it protects investors from the economic downturns of a single nation.

Resource seeking

Put simply, a company may find it cheaper to produce its product in a foreign subsidiary- for the purpose of selling it either at home or in foreign markets. The foreign facility may be able to obtain superior or less costly access to the inputs of production (land, labour, capital, and natural resources) than at home.

Strategic asset seeking

Firms may seek to invest in other companies abroad to help build strategic assets, such as distribution networks or new technology. This may involve the establishment of partnerships with other existing foreign firms that specialise in certain aspects of production.

Efficiency seeking

Multinational companies may also seek to reorganise their overseas holdings in response to broader economic changes. For example, the creation of a new free trade agreement among a group of countries may suddenly make a facility located in one of those countries more competitive, because of access for the facility to lower tariff rates within the group. Fluctuations in exchange rates may also change the profit calculations of a firm, leading the firm to shift the allocation of its resources.

The list of reasons for investing abroad doesn’t stop there. As a matter of fact, each company is managed differently and therefore will benefit from the situation differently which makes this list endless. But it’s also very important to consider the risks you are taking before making such a move:

Currency risk

The most serious risk you run when investing abroad is from currency movements. You may be lucky enough to invest in a foreign share that runs up 50%. But if the local currency halves in value against the pound, you will be no better off by selling at that point.

In countries that are prone to devaluing their currency, foreign investors can incur catastrophic losses overnight. It was a wave of such devaluations that triggered the Asian crisis in 1998. At the height of the panic, some shares even in the developed market of Hong Kong could not be sold at any price. The mere fear that the authorities would devalue was temporarily enough to paralyse the market – even though that fear proved groundless.

Anticipating currency movements is no easy task. But you can reduce your exposure to foreign currencies by simply practicing sensible diversification. If you spread your holdings amongst several countries, it is most unlikely that all their exchange rates will move against you simultaneously. Some will probably move to your advantage.

Unstable governments and geopolitical factors

Wars, abrupt changes in government policy with regards to business, and markets that aren’t highly developed are all unpredictable, and such risks are heightened emerging-market economies.

Custody risk

Under UK law, you enjoy a high degree of protection when you place your money with an authorised UK investment firm. Any losses you suffer if the firm collapses will be made good to a maximum of £48,000. The scheme is funded by insurance contributions paid for by member firms, and ultimately backed by the government’s own guarantee.

Sadly, you do not enjoy the same protection when you invest with foreign firms. They may operate under laws that protect citizens in their own country, but those laws do not extend to foreign investors. It is therefore possible that you may lose everything in the event of fraud, negligence or mismanagement.

One way to minimise custody risk abroad is by sticking to shares, trusts and other financial assets that are managed or held by authorised UK firms only. Or by investing in companies that are too large to be allowed by the authorities to fail and/or covered by an insurance scheme that will compensate their clients against loss due to fraud or negligence and/or highly reputable.

Here again the list is very long but this time mainly because markets change constantly and what’s working in your advantage today might not be the case tomorrow.

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