Ten Traps to Avoid When Taking Your Investments Global

In this economy, it is important to understand how other countries can affect the global market and your investment portfolio. From politics to natural disasters to financial crises, any number of foreign factors can influence the way our domestic financial investments work. In addition, there are lesser-developed countries offering incredible investment opportunities for private investors. “Emerging markets” is the term used to describe these opportunities—and since they represent about 75 percent of the world’s land mass and are home to over 80 percent of the global population—they are certainly worth any investor’s consideration.

In the newly released Emerging Markets For Dummies^® (Wiley, January 2011, ISBN: 978-0-470-87893-4), financial expert Ann C. Logue provides all the information you’ll need to improve your investment performance. An important way to do that, she says, is to avoid the mistakes that can drag down your returns.

“All sorts of investors make all sorts of mistakes,” she explains, “but certain errors are particularly common among emerging-market investors. They add to your risk and increase your headaches.”

In fact, Logue continues, there are ten traps every investor should avoid. Read on for some common and not-so-common mistakes every emerging market investor should watch out for:

Expecting outsized profits. In 2009, the MSCI Emerging Markets Index increased 74.5 percent on a U.S. dollar basis. Wow! But the index’s annualized return for the ten years ending in 2009 was just 7.29 percent—better performance than the U.S. markets, but nowhere near 74.5 percent.

“Although investors take on the risk of emerging markets in order to receive a higher return, those returns won’t necessarily be earth-shatteringly huge every single year,” explains Logue. “The long term trend in emerging markets is toward faster growth and higher profits than you’re likely to find in the developing world, but the results in any one year could be down. When they’re up, they tend to be up by more than the developed markets, and when they’re down, they tend to be down by more, too. You should expect profits, but also expect a lot of variation from one year to the next. The good news? Your patience will probably be rewarded.”

Disregarding Politics. It would be nice sometimes if the politicians decided to stop talking and go home, wouldn’t it? But they don’t. As frustrating as it is sometimes, the political process is a way of getting things done. Unfortunately, it can interfere with business and investing activities.

“The importance of the market and the value of entrepreneurs vary from place to place,” Logue says. “Some politicians care more about staying in power than about what’s best for commerce or for investing. Many emerging and frontier markets are making progress after decades, or even centuries, of bad government and inattentive leadership. When investing in emerging markets, you should pay attention to the political mood of the countries where you have your cash. The appendix has several resources that can help with that task.”

Not understanding how the rules of the game differ. When you invest in an emerging market, you face a different set of rules about ownership, contracts, and shareholder rights. It’s tough to generalize because every country is different, but that’s the point. Because the legal situation varies from country to country, you need to know what your rights are and what rules apply to the game you’re playing.

“You have to do your research,” asserts Logue. “You want to find out how much ownership stake your investment gives you, what your legal rights are in the event of bankruptcy, and whether shareholders can vote on acquisition offers. Much of this information can be found in offering documents, prospectuses, and other corporate filings. If you’re making a direct investment in another country, talk to a lawyer who understands the situation.”

Taking a flyer without research. You reduce your risk and improve your comfort level by spending just a bit of time looking into any investment ahead of time. Emerging markets move fast, but they don’t move that fast! You don’t need to get into them right this very minute.

“Take the time to do your work so that you understand all the ins and outs of your emerging-market investment,” Logue says. “Companies issue annual reports and mutual fund companies print prospectuses. Fix a cup of coffee, sit down, and read them. Do some basic Internet searching to get information on the company offering the investment and the country where it’s based. Is the return potential clear? Are the risks at a level you can live with? It doesn’t take long to get answers, and this research can help you avoid a financial disaster.”

Ignoring closed-end funds. Closed-end funds are a bit different from traditional open-ended mutual funds, and they’re a good way to handle the volatility and liquidity issues that come with investing in many emerging markets. Here’s how they work: The initial investors pool their money and buy securities in a predetermined market, and then the fund holds an initial public offering. After that point, anyone who wants to buy or sell shares in the fund has to do so through the stock exchange; there are not redemptions through the fund company. You’d think that the fund’s price would reflect the value of the securities in the investment pool, but it usually doesn’t. Instead, the closed-end fund’s price is usually below the value of the securities, and puts off a lot of investors.

“Although they sometimes have pricing problems, closed-end funds have some advantages for emerging-markets investors,” Logue continues. “Because the fund’s investments don’t have to be sold to meet redemptions, the fund manages can keep a long-term focus and invest in securities that can’t be sold easily. This gives fund managers more flexibility and may lead to a better return than with a traditional open-ended mutual fund.”

Overlooking home-country investments. You don’t have to invest overseas to get exposure to emerging markets. Most of the growth for pharmaceutical companies, consumer product companies, and engineering-construction firms comes as these businesses find new way to reach customers in markets that they couldn’t get to before. Billions of people in this world don’t wear deodorant, drink pop, or use bank accounts—and thousands of companies in developed countries are looking to help them out.

“In addition to multinational corporations, you can invest in emerging markets through mutual funds, exchange-traded funds, or companies that issues depository receipts on your home stock exchange,” Logue says. “You don’t need a special brokerage account, nor do you have to exchange any currency.”

Getting swept up in currency headaches. Exchange rates can affect your investment returns and add to the overall volatility of emerging market investing. The effects of currency in any one year can be dramatic. In 2009, the MSCI Emerging Markets Index increased 74.5 percent on a U.S. dollar basis but 58.65 percent when looking at local currency only. Because emerging market currencies grew stronger against the dollar, dollar-based returns were higher. Over a longer time period, currency made less of a difference in returns. The annualized return for the MSCI Emerging Markets Index for the ten years ending in 2009 was just 7.29 percent on a dollar basis and 5.38 percent when calculated in each market’s currency.

“Exchange rates are going to move up and down from year to year,” explains Logue. “Over the long run, though, the fluctuations tend to be less important. If you feel confident about the economic and political climate in a country, you probably don’t need to worry too much about exchange rates.”

Focusing only on the BRICs. Brazil, Russia, India, and China are big markets offering huge opportunities for investors. But they aren’t the only emerging markets out there. MSCI Barra, the company that creates and maintains the standard index of emerging markets, places 17 other countries in the “emerging” category and another 29 in the “frontier” group.

“With so many choices, you have a lot of ways to find good value, great opportunity, and robust diversifications,” Logue asserts. “You may also come across the Next Big Thing. Wouldn’t that be exciting?”

Falling victim to outright scams. Oh, the opportunities abound! And so do the rip-offs. Emerging markets investors sometimes face the same tax evasion, misappropriation, and general fraud that are perpetrated by executives anywhere. But at times, the lack of transparency and the legal structure’s murkiness can lead investors into a boggling array of scams. For example, some investors have bought into offshore real-estate deals, only to discover that the country‘s laws don’t allow citizens to own land. They’ve taken stakes in nonexistent mines or been persuaded to fund start-ups that always seem to need just a few thousand dollars more in order to rev up the business.

“If it seems too good to be true, it probably is,” Logue says. “The best way to protect yourself is to maintain a healthy skepticism. A lot of people are looking to invest in emerging markets, so why would you be offered some kind of super-special secret deal before everyone else? And if you’re making a direct investment rather than buying a security, by all means, hire a lawyer who understands contract law in that market.”

Losing it all to nationalism. It happens sometimes: The rules change, and the company you invested in is no longer a private company. It may be forced out of business or taken over by the government, and you can’t do anything about it. This risk is especially big in pre-emerging and frontier markets, where the politics may not be settled and the people may be less comfortable with capitalism.

“All you can do is keep an eye on the country’s politics and sell if you become especially nervous,” says Logue. “It may sound simple, but it’s true.”

“We truly live in a global society,” Logue continues, “and our financial world is no exception. The most important thing you can do in any investment situation is to educate yourself. Take the time to read all the facts, familiarize yourself with the details, and ask around for second opinions. All it takes is a little bit of extra effort for that big payoff. And if you play the game smart, you’ll win big in the end.”