Investment in non domestic equity securities
The economies have got integrated in recent decades and with technological advancements, it has become significantly easier for investors to make international investments at low cost. This has allowed economies to develop and stabilize. If you are willing to invest in non domestic equity securities, it can be made directly or through depository receipts, global registered shares, or baskets of listed depository receipts. However, there might be restrictions for investments in particular economies to reduce volatility in financial markets and provide better returns to domestic investors. Let’s talk about some ways through which investment in foreign equity securities can be made.
It refers to buying and selling securities directly in foreign markets and hence, all transactions are in the company’s and not the investor’s domestic currency. However, investing directly may lead to less transparency and more volatility. Also, there are some potential issues if an individual investor route for direct investment route:
Investors must be aware regarding the foreign laws and their investment environment.
The disclosure requirements might be low in some countries impeding the analysis process.
Returns are also exposed to currency risk that might impact the actual return earned by the investor.
Meaning, a Japanese investor who invests in euro-denominated shares will have greater yen based returns if euro appreciates relative to yen.
Now, let's discuss how you can invest in DRs, if direct investment is not your favourable option. DRs represent ownership in a foreign firm and are traded in markets of other countries in local market currencies. This investment route includes Global depository receipts, American depository receipts, global registered shares and baskets of listed depository receipts.
When foreign shares are deposited in a bank, depository receipts are issued representing ownership of a specific number of foreign shares. The receipts then trade on local exchanges in local currency.
The depository bank acts as a custodian and manages all related events such as dividends, stock splits, etc. Depository receipts offer the investor the same right as offered to an investor in direct investment, however, are usually more regulated.
DRs are further Sponsored or Unsponsored.
Sponsored DR: If a firm is involved with the issue of DRs, then it is referred as sponsored DR. It provides investors with voting rights and has greater disclosure requirements.
Unsponsored DR: A foreign company is not involved in the issue of DRs and hence the bank retains the voting rights.
Global Depository receipts are issued outside the company’s home country and outside the United States. GDRs are not subject to capital flow restrictions and thus offer great opportunities for foreign investment. However, the majority of GDRs are denominated in US dollars.
American depository receipts are denominated in US dollars and trade on US exchanges. ADRs are based on American depositary shares (ADS) which trades in the firm's domestic market. Some ADRs also allow firms to raise capital in the United States or use the shares to acquire other firms.
ADRs are generally of four types with different levels of corporate governance and filing requirements,
Global Registered Shares
It is a common share that is traded on different stock exchanges around the world in different currencies. Hence, GRS are more flexible than depository receipts as they can be traded anywhere without currency conversion and represents an actual ownership interest.
A basket of listed depository receipts is an exchange traded fund that is a collection of depository receipts. ETF shares trade in the market just like common stocks. These Securities allow investors to gain broader exposure and can also be implemented into hedging or arbitrage strategies.
The return on equity investments consists of price changes, dividend payments or gain/losses from changes in exchange rate. Gain from dividend and its reinvestment have been an important part of equity investors long term investments. The risk, however, is measured by the standard deviation of returns.