How to Buy Foreign Stocks as An American Investor
A running joke here at Nanalyze is referring to “the great country of Africa,” a place that most Americans associate with safaris. It’s humorous because it’s an ignorant thing to say. Africa isn’t a country, it’s a continent consisting of 54 countries, each with its own culture and idiosyncrasies. (Surprisingly, around half are dictatorships.) Nearly 28% of the 193 countries recognized by the United Nations can be found on the continent of Africa. Point is, the world is a big place, and we should all be looking outside our own backyards to better understand it.
Investors tend to invest in what they know, but not in the way Warren Buffet suggests. They’ll look in their own backyard for investment opportunities instead of looking at the entire global opportunity, something referred to as “home bias” or “domestic bias”. Economists cannot explain why investors do this, making domestic bias one of the six major puzzles in international macroeconomics.
When it comes to equities (stocks), global index provider MSCI (MSCI) provides us with a way to see how 99% of the global investment opportunity is allocated across countries. Just over 59% is in the United States.
If your stock portfolio doesn’t match the above country allocation, that means you’re actively betting that certain countries will outperform others. Many U.S. investors only hold U.S. stocks. Now that we understand why American investors may want exposure to international stocks, we can look at how one might go about investing in international stocks. Since just over half our readers hail from America, that’s who this article is for.
Investing in Foreign Stocks with Interactive Brokers
In our own tech stock portfolio, we’re holding multiple stocks that trade on foreign markets. To do so, we use a brokerage firm called Interactive Brokers (IB) which lets us trade foreign shares on dozens of foreign exchanges. That’s because we command a certain amount of assets under management (AUM), and are considered “experienced investors.” (We like to think of ourselves as a drinking club with an investing problem.) Being qualified to trade on foreign exchanges at IB is a pre-approval process which not all will qualify for. Just because you open an account with IB doesn’t necessarily mean you’ll be able to trade stocks on foreign exchanges.
There’s also some added complexity when buying foreign stocks on IB because you’ll need to do it using the local currency. For example, many subscribers have asked us about buying shares of BICO Group (BICO.ST). Using Interactive Brokers, you first need to buy some Swedish Krona (SEK), then use that money to buy shares on the Stockholm Stock Exchange (after requesting approval, of course). Note that while IB provides – as most brokers do these days – free trading, there may be additional fees tacked on to trade stocks on foreign exchanges. To learn more about this process, see our previous piece titled Trading Tech Stocks on International Stock Exchanges.
We use Interactive Brokers to invest in all the foreign companies we hold, similar to the example we’ve given you of BICO Group. But there’s a much simpler way to invest in some foreign companies – the American Depository Receipt (ADR) method.
Investing in Foreign Stocks Using ADRs
The first American Depository Receipt (ADR) was issued by J.P. Morgan back in 1927 when they made British company Selfridges available to American investors. Essentially, here’s how that process worked back then, and still works to this day.
- A chunk of Selfridge’s shares are bought on the London Stock Exchange and deposited in a custodial account such as a large U.S. bank – let’s say one million shares at one quid per share.
- A new stock ticker is created for the U.S. market that represents 10 shares of Selfridges – 10 quid worth of shares.
- 10 quid equals $13.36 so that’s the price the Selfridges ADR starts trading at.
- As exchange rates or the London-quoted stock price change, so does the price of the ADR.
Once the ADR is created, it can then trade seamlessly on a major U.S. exchange. One of the most liquid ADRs out there is British Petroleum, and here’s how we can reconcile the NYSE-traded stock price against the London Stock Exchange (LSE) stock price.
- London Stock Exchange Listing (BP.L) = 345.15 pence = 3.4515 pounds per share = $4.61 USD
- NYSE Listing (BP) represents 6 ordinary shares of BP – current price = $27.45 USD
- 6 X $4.61 = $27.66 USD
As you can see in the above example, shares of BP that trade on the LSE are priced about the same as shares of BP that trade on the NYSE (just a 21 cent difference). This makes sense. If the prices deviate too much between the two issues, then the difference will be removed by arbitrage. Note that there is no such thing as a free lunch, so there will be fees happening in the background.
The institutions that issue ADRs may charge quarterly or annual ‘ADR Pass-Through Fees,’ which consist of custody fees and fees for processing dividends and corporate actions.Credit: Charles Schwab
ADRs don’t just trade on major U.S. exchanges, but also on exchanges operated by the OTC Markets group.
Investing in Foreign Stocks Using Exchanges Operated by the OTC Markets group
Many of our paid subscribers have been asking us about trading shares of foreign companies on exchanges operated by the OTC Markets group, something we’ve done ourselves in the past. To better understand this mechanism, we reached out to OTC Markets group and talked to their Advisor Relations team about how the process works.
A market maker is an institution that does what it says on the tin – they make a market for trading shares by playing matchmaker between investors who want to buy shares and investors who want to sell shares. On exchanges operated by the OTC Markets group, you’ll see many stock tickers that are five letters with the last one always being the letter “F.” These used to be called “F Shares,” but OTC Markets group would rather investors refer to them as what they actually represent – ordinary shares in a company.
Let’s go back to our example of BICO Group. One ticker for BICO Group ordinary shares is CLLKF. When you buy shares of CLLKF, the market maker takes your order and executes it on the foreign stock exchange. Once executed, that position consisting of ordinary shares is reflected in your own portfolio at your brokerage account. It’s as simple as that. Owning a company that trades as an “F share” on the OTC exchange is synonymous with owning the actual company. Liquidity and settlement always happen on the local market where the shares are traded. The ticker on the OTC exchange actually shares the same ISIN (a unique identifier used in the finance world) as the ordinary shares because they are one and the same.
Liquidity for some ADRs may be low, which may affect bid/ask spreads.Credit: Charles Schwab
The Liquidity Problem
It’s worth mentioning another “feature” of foreign stocks that trade on exchanges operated by the OTC Markets group which is low liquidity. This means that bid/ask spreads can get quite wide. If you don’t know what that means, don’t worry. We’ll explain this in simple terms using our earlier example of BICO Group. Here’s the latest price from Google Finance.
Just look how low the volume is. On an average day, the total amount of shares traded is about $6,400 USD worth. If you wanted to open a $10,000 position, it could take you a while. The price of $37.42 seen above isn’t that far off from the actual price of 338.6 SEK (which translates to $38.86). However, here’s what the bid/ask spread might look like when you go to trade it:
- ASK (For Sale): 100 shares at $40 a share
- BID (Want to Buy): 100 shares at $36 a share
See how that works? As a buyer, you’re paying more for shares than you should. As a seller, you’re receiving less than you should. When there’s low liquidity, you can expect large bid/ask spreads. Don’t like it? Go create your own market-making firm and you’ll run into the same problems. That’s just how supply and demand works. When you trade low-liquidity stocks on the OTCQX exchange, you should do your own due diligence so you know what you are buying and how much you are paying for it.
DISCLAIMER: We’re now going to stop talking about exchanges operated by the OTC Markets group and talk about something entirely different that is relevant to U.S. investors investing in foreign stocks and has nothing whatsoever to do with exchanges operated by the OTC Markets group.
Investing in Chinese Stocks
Emerging markets often bring more complexities to the table. There’s an exception to the rule worth noting for ADRs which is how China imposes rules that limit foreign investments. To circumvent these rules, Chinese firms have created sophisticated mechanisms called variable interest entities (VIEs) which involve multiple foreign jurisdictions and are nearly impossible to understand.
All the Chinese tech companies we’re aware of that trade in the United States use VIE structures. When we learned about the risks associated with these structures in Fall of 2020, we decided to not hold Chinese stocks, and sold our largest holding at the time – Ali Baba (BABA). It turned out to be a well-timed sale, because since then, investors have become increasingly skittish when it comes to Chinese stocks. The China growth opportunity shows an incredible amount of promise for investors, but we cannot justify the risks associated with holding shares of VIE structures that provide no assurance that we’re actually holding shares of the underlying company. Should everything go pear-shaped, holders of shares in VIE structures will have no legal recourse to the shares they think they’re holding. That might seem a bit incredulous, but don’t take our word for it.
We now return you to your regularly scheduled programming.
A List of Foreign Stocks
Over the years, we’ve covered hundreds of global tech stocks, many of which can be found in the Nanalyze Disruptive Tech Stock Catalog which now contains over 360 tech stocks. Of these, about 10% are listed as ordinary shares on exchanges operated by the OTC Markets group. We’ve provided a list of these global stocks as follows (company names link to our research):
|Tech Theme||Company Name||F Share Ticker|
|AR/VR Content||Mirriad Advertising||MMDDF|
|AR/VR Hardware||Smart Eye||SMTEF|
|AR/VR Hardware||HTC Corporation||HTCXF|
|AR/VR Hardware||AMS AG||AUKUF|
|AI Healthcare||RaySearch Laboratories||RSLBF|
|Quantum Computing||Archer Materials||ARRXF|
|Fintech – General||Adyen||ADYYF|
|Venture Capital||Scottish Mortgage Investment Trust||STMZF|
|Venture Capital||Draper Esprit||GRWXF|
|Fuel Cells||ITM Power||ITMPF|
|Fuel Cells||Ceres Power Holdings||CPWHF|
|Fuel Cells||AFC Energy||AFGYF|
|Renewable Energy||Vestas Wind Systems||VWSYF|
|Renewable Energy||Carnegie Clean Energy||CWGYF|
|Waste Management||Aker Carbon Capture||AKCCF|
|Graphene||Haydale Graphene Industries||HDGHF|
|Graphene||Applied Graphene Materials||APGMY|
|Industrial Robots||Ocado Group||OCDGF|
|Industrial Robots||Fastbrick Robotics||FBRKF|
Nanalyze Premium annual subscribers have full access to this catalog which gets updated once a month, and which contains our own stock rating – love (we hold the stock), like (we like the stock but don’t hold it), and avoid (we would avoid the stock).
If you want to dabble in international stocks, the best place to start is by speaking with your existing broker. TD Ameritrade will have different policies than Charles Schwab. Both brokers will treat clients differently depending on their various service tiers. Start there and always do your own due diligence as to what you’re buying and at what price. Broadly speaking, any major brokerage firm won’t let you get yourself in too much trouble by forcing you to set trade limits when you’re dabbling in low liquidity stocks.
There are numerous ways to buy shares of non-U.S. stocks as a U.S. investor. The method we use and strongly recommend is Interactive Brokers, but there are other ways. Any time a non-U.S. company is being traded on exchanges operated by the OTC Markets group with a five-digit ticker which ends in “F,” it’s a safe way to buy shares. Don’t expect there to be a lot of liquidity, but that shouldn’t matter if you’re someone who is holding stocks for the long term. It’s about time in the market, not timing the market.
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