Should I Invest in Emerging Markets?

Investments in Emerging Markets has been on attractive investment avenue for several years. Emerging markets provide an opportunity for faster growth of your portfolio. BRIC report published by Goldman Sachs in 2003 and then subsequently released revisions through 2010 has predicted that Brazil, Russia, India and China could be among the 4 most dominant economies by 2050.

Each country passes through its own economic cycles and the key indicators of the economy recalibrate themselves to adjust to the new reality. While it is still advisable to invest a sizeable amount of money in your home country, it would be a good idea to investment in other countries that provide a promise for better returns.

Investments can be in the form of mutual funds offered by your home country that invest in foreign companies (International Equity Funds) or you can directly invest in the local markets of the foreign country. The latter would require you to convert currency to the international market whereas the latter would mandate that you invest in foreign currency and when you are ready to get the sales proceeds back you convert back to your home currency and realize the gains.

This would bring another element of risk in your portfolio in addition to the foreign market risk i.e. the risk of currency fluctuation. In a few cases, despite this risk, you may end up getting better returns on your investments.

I have tried to analyze a few critical points that you would need to consider when investing in foreign countries.

Key Considerations

Diversification

If you are in a developing economy, it would help invest portion of your money in a developed economy. This will protect you from higher volatility that is usually observed in a developing economy. This helps in 2 ways: (1) De-risk your Portfolio: Find a better quality egg to keep in the basket and (2) Diversify: Have more avenues to invest

Exchange Rate Risks

Irrespective of your investments are through an International Equity Fund or directly in the foreign country, you would be subject to exchange rate fluctuations. In the former case the fund house would need to manage the currency fluctuation for their invested portfolio in foreign countries and in the latter case, you will have to manage this risk.

Portfolio Administration

If plan to go the DYI route for your foreign investments, you would need to take an additional burden on yourself viz. setup account(s) that would allow seamless flow between accounts in the two countries. These would be bank accounts, stock trading accounts, deposit accounts. These accounts would be subject to law of the foreign country where you plan to invest. You will need to know the taxation rules for the foreign country, repatriation restrictions, fees and charges.

Taxation

Taxation would be a key determinant for the returns. There are countries that offer zero tax or significantly lower taxes. Their prime purpose is to attract foreign capital to sustain their economy. These would be good countries to consider if the other charges and exchange rate variations are lower too. In a few cases, you would need to consider how your home country will consider the taxation on these investments.

Double Tax Avoidance

USA has a Double Tax Avoidance Treaty with more than 50 other countries. Under these treaties, residents of foreign countries are taxed at a reduced rate, or are exempt from U.S. taxes on certain items of income they receive from sources within the United States. Depending on the nature of the treaty, you may have to pay in your home country the difference in tax rates between your home country and the foreign country where you made the gain.

Tax Returns and Income Declaration

In a few cases you may have to employ services of an certified accountant in the foreign country to help you with your tax returns. These costs need to be factored in when making your decision.

Repatriation

Repatriation means bringing your own money back to your home country. A few countries have a limit on amount that can be repatriated in a given year. You may not be able to repatriate all the money in one go. Usually the amount that can be repatriate in a financial year is very high. It’s a good idea to check this before making the decision.

Conclusion

Given the various considerations and complications you would be better off to lean more towards more passive investment strategy in foreign companies. You need to be fully aware that the published absolute return will be reduced by the fees, charges and taxes that you would have to pay in the foreign company. The most important consideration when making investments in a foreign country is your familiarity and comfort with the country. Having said all this, in most cases the returns from your investments net of charges, currency fluctuations and risks would be worth it!