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I was told a while ago that foreign stocks are more risky than local stocks. Is this true?

What is considered foreign depends where you are (for example, a US based investor would consider US stocks as local, but someone outside the US would consider the same stocks as foreign). Since local and foreign are relative terms, can the same stock be considered more risky purely because it was brought by a foreign investor? And if so, why?

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  • Just personally, I invest in foreign mutual funds when the market in the US does well, and the opposite when it does poorly. Although I'm not sure about specifics of stocks (as I invest in more broad funds rather than specific stocks), I can say that funds in general follow set patterns and in some cases are a safer "bet" when investing. I can't say this answers the question, but rather shows a bit of how personally, risk is relative. – Anoplexian Oct 17 '16 at 15:53
  • @Anoplexian good point. I usually invest in funds too, actually. – user40750 Oct 17 '16 at 19:22
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    Foreign stock is local stock for those living there. :) So the issue is not in the stock, it is the currency as others has described. And that is true for not just stocks, but other financial instruments involving currency and the like. – Viktor Mellgren Oct 18 '16 at 11:29
  • one point that I don't think has been mentioned is that when selling this foreign stock, you are required to pay capital gains tax according to that foreign government. – ldgorman Sep 29 '17 at 9:35
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Foreign stocks have two extra sources of risk attached to them; exchange rate and political.

Exchange rate risk is obvious; if I buy a stock in a foreign currency and there is a currency movement that makes that investment worth less I lose money no matter what the stock does. This can be offset using exchange rate swaps. (This is ceteris paribus, of course; changes in exchange rate can give a comparative advantage to international and exporting companies that will improve the fundamentals and so increase the price of the stock relative to a local firm. The economics of the firms in particular are not explored in this answer as it would get too complicated and long if I did.)

Political risk relates not only to the problems surrounding international politics such as a country deciding that foreign nationals may no longer own shares in their national industries or deciding to seize foreign nationals' assets as happens in some areas. Your home country may also decide to apply sanctions to the country in which you are invested thus making it impossible to get your money back even though the foreign country will allow you to redeem them or sell. Diplomatic relations and trade agreements tend to be difficult. There are further problems in lack of understanding of foreign countries' laws, tax code, customs etc. relating to investments and the necessity to find legal representation in a country you may never have visited if there are issues.

There is also a hidden risk in that, as an individual investor, you are not likely to be reading the local financial news for that country regularly enough to spot company specific issues arising. By the time these issues get into international media its far too late as all of the local investors have sold out of their positions already.

The risks are probably no different if you have the time to monitor international relations and the foreign country's news, and have FX swaps in place to counteract FX risk as the funds and investment banks do but as an individual investor the time required is not feasible.

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    "Exchange rate" is actually not a direct risk. Take e.g. two international insurers, one listed in Europe and one in the US, but both sell 50/50 in US and Europe. That is to say, both have the same exposure to currency fluctuations, but one is listed in USD and one in EUR. If the EUR goes down relative to the USD, the European-listed company will appear to have a a competitive advantage, in that its profit in EUR rises. Its stock will rise, as listed in EUR. The US company will see the inverse, but in USD. However, for a American holding the European stock, that gain is purely numerical. – MSalters Oct 17 '16 at 14:13
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    I was thinking of the Argentine government bond market when I wrote this actually! – MD-Tech Oct 17 '16 at 14:17
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    There is a counter political risk: most of your assets (like your citizenship) is tied to your current country. Political insanity "at home" can cause your assets (your ability to work, live, own) to fall in a correlated manner. Overseas assets have some similar risks, but the are not correlated. And spreading assets over areas whose risks are uncorrelated generates less net risk! The assumption (that "here" will be stable, but "there" not) is a natural one to make, but easily over-assumed. Everyone who fled a violent revolution and followed their money will understand this. – Yakk Oct 17 '16 at 20:26
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    @MSalters But they don't have the same exposure to currency fluctuations. One has exposure to currency fluctuations because you hold the stock and you value things in a different currency. The other has exposure to currency fluctuations because they are a multi-national or cross-national business. These are not the same exposure at all. One can be managed and hedged by the company. One will be included in the company's forecasts, planning, and price. They are just not really comparable risks even though they both are ultimately caused by the chance of currency fluctuations. – David Schwartz Oct 17 '16 at 20:45
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    @AlexR that's only true if you purchase an ADR and not the stock directly. – MD-Tech Oct 18 '16 at 10:09
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In addition to @MD-tech's answer:

  • I'd distinguish between stock of a foreign company traded in local currency at a local exchange from the same stock traded in the foreign currency at a foreign exchange (and maybe with a foreign bank holding your accounts).
    The latter option will typically have higher variation because of exchange rate, and (usually) higher risks associated with possibility of recovery, (double) taxation and the possible legal difficulties @MD-tech mentions.
    Trading the foreign stock at a local exchange may mean that the transaction volume is far lower than at their "home" exchange.

  • Holding stock of companies working in foreign markets OTOH can be seen as diversification and may lower your risk. If you only invest in the local market, your investments may be subject to the same economic fluctuations that your wage/employment/pension situation is subject to - it may be good to try de-correlating this a bit.

  • Of course, depending on political circumstances in your home country, foreign investments may be less risky (though I'd suspect these home countries also come with a high risk of seizing foreign investments...)

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  • yes I suppose I should have added that it can also decrease risk. thanks for mentioning it – MD-Tech Oct 17 '16 at 14:49
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    If the foreign stock is traded in local currency, that means someone else is absorbing the risk to create a "currency neutral" form of that stock. This is often seen in mutual funds and such. Sometimes banks and investment firms offer two versions of the "same" fund: a currency neutral one and regular. The underlying mechanism must be that, effectively, the fund is run by a Forex trading entity who is somehow taking the Forex risk, and offering the stock to locals in the local currency. Perhaps internal to the fund there is a hedging position based on Forex futures contracts. – Kaz Oct 17 '16 at 19:06
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The value of a foreign stock is subject to fluctuations in the foreign currency value; this is not the case for domestic stocks.

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    Sure it is, many large companies listed on the UK stock exchange make a lot of their earnings in dollars. A UK investor investing in UK stocks is exposed to dollar/pound fluctuations because of that. – Robert Longson Oct 17 '16 at 20:16
  • Most of Apple's cash is held in foreign banks in foreign currencies. – quid Oct 18 '16 at 17:02
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Others have mentioned the exchange rate, but this can play out in various ways. One thing we've seen since the "Brexit" vote is that the GBP/USD has fallen dramatically, but the value of the FTSE has gone up. This is partly due to many the companies listed there operating largely outside the UK, so their value is more linked to the dollar than the pound.

It can definitely make sense to invest in stocks in a country more stable than your own, if feasible and not too expensive. Some years ago I took the 50/50 UK/US option for my (UK) pension, and it's worked out very well so far.

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    If the pound goes down but FTSE shares go up, how much of that is just treading water i.e. the underlying value hasn't really changed? (FTSE shares being quoted in pounds, after all...) – Michael Oct 17 '16 at 18:09
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One risk not mentioned is that foreign stock might be thinly traded on your local stock market, so you will find it harder to buy and sell, and you will be late to the game if there is some sudden change in the share price in the original country.

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    There is an implicit assumption in most of these answers that the stock is not traded locally at all. – MD-Tech Oct 18 '16 at 9:02
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If you intend to be responsive to news and intraday price moves, for foreign stocks these will often happen while you're asleep (e.g. the Tokyo Stock Exchange opens at roughly midnight UK time).

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It is very important to note the strength and reputation of the country's regulatory agency. You cannot assume the standards of say the SEC (US Securities and Exchange Commission) apply in other countries (even well-developed ones). These regulations force companies to disclose certain information to inform and protect investors. The standards for such practices vary internationally.

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