Dateline: Kuala Lumpur, Malaysia
I was recently reading an investing blog where a US person made the (paraphrased) comment: “I’d like to earn 10X higher yields investing in South Africa, but they have a lot of wars and stuff there, so I’d rather invest in Canada and make just a little more. At least there is no risk there.”
If you read this site frequently, you know that those are famous last words.
In fact, you might as well put “there is no risk there” right next to “real estate never goes down”.
Investing overseas, be it in stocks, real estate, or anything else, seems risky to the average investor at first blush.
After all, why invest overseas when domestic stocks are so great? Hey, the Dow just reached a new high!
In most cases, the reality is that risk is merely something that investors perceive, not something that actually exists. To me, it’s hard to think of too many examples of strictly geographical risk.
The examples I can come up with can be just as easily found in highly developed western markets like Canada or the United States. Many of these perceived risks are actually far more prevalent in some form or fashion in “wealthy”, “democratic” countries. In many cases, the four risks to investing overseas already exist in your own backyard but are covered up buy cute-sounding names. (We’ll get into that in a minute.)
The bottom line is that investing overseas is no different from investing at home. Yes, some countries have “wars and stuff”, but there are plenty of people making money while that goes on.
Heck, there are even people making money from those wars going on. (Let’s start with Halliburton).
Of course, these wars and other incidents are largely sensationalized and politicized to begin with.
I still remember people shaking in their boots and begging me to stay safe when I first visited Belfast, Northern Ireland a number of years ago. Years after any serious damage had happened, the media still had them convinced that I was walking into a war zone.
Similarly, fellow travelers told me not to stay out past dark in Phnom Penh, Cambodia because there are no street lights there. That claim is patently false, also. Surely, however, plenty of travelers and investors alike have heard such claims and decided to stay away, sticking to the comforts of home.
If you have never been to a place, it’s hard to judge the risks. I believe that 90% of the time, going to a place will show you just how overblown any risks you imagined are.
So today, I wanted to go over the four big risks when it comes to investing overseas.
1. Currency Risk.
Here in Malaysia, the Malaysian ringgit has tanked some 10% against the US dollar in the last few months, all thanks to low oil prices. If you purchased a condo here earlier this year, you would have lost 10% of your investment’s value in US dollars.
Of course, that is not to say that the ringgit won’t recover and rally the way it and other emerging market currencies did in 2009. It’s also a bit esoteric in that an important aspect of international investing is diversification, including currency diversification. Thinking of all of your assets merely in US dollar terms is a strategy that degrades the benefits of diversification.
2. Liquidity Risk.
I frequently see stock-and-bond commentators bemoaning the liquidity issues when investing overseas. While it’s true that the Mongolian stock market is very thinly traded and selling shares in a brewery in Ulanbataar might be a bit difficult, selling real estate in Mongolia’s capital isn’t much different than selling real estate in Los Angeles.
While markets of any type experience ups and downs, the fact that wealthy oligarchs snatch up $50 million mansions in Beverly Hills the day they’re listed while selling an apartment in Asia takes a few months these days does not mean that Asia has a liquidity problem. Inherently, most investments of a similar nature have similar liquidity all around the world, be it for good or bad.
3. Transaction Cost Risk.
Sending money overseas does have a higher cost, especially if you’re living in the United States where apparently high-earning bankers haven’t even heard of Singapore.
However, transaction costs don’t have to be higher overseas. While I love using offshore strategies to pay as little tax as legally possible, that doesn’t mean you shouldn’t be willing to pay some tax if the deal is good. And different countries tax in different ways.
For example, round-trip transaction costs on real estate in Hungary approach 10%, even on the buy-side. While that’s certainly much higher than the near-zero transaction costs for cash buyers of real estate in the United States, Budapest real estate is some of the cheapest in Europe and offers an attractive yield proposition.
Meanwhile, some other countries charge similarly high transaction fees but have no property tax, meaning you pay more upfront but less over time.
While transaction costs on buying stocks are often higher in other countries, the fees for real estate and alternative investments are often lower. So are the costs of transferring money and converting currency outside of the US and Canada.
4. Expropriation Risk.
There are two types of expropriation: direct and indirect.
The government coming in and snatching up every single piece of private property under the banner of “agrarian reform” is pretty close to direct expropriation as you can get.
On the other hand, the government increasing property taxes eight-fold to the point where half of the country can no longer afford to maintain ownership of their home is an indirect form of expropriation that happens all the time.
This is the type more common in the “safe” western world, which is also quite fond of the practice of eminent domain to build roads and bridges for their crony capitalist friends.
In countries like Nicaragua and Cambodia where expropriation was an issue in some of our lifetimes, many of the communists have now magically become capitalists. They love the economic benefits and largesse that comes from foreign investors, and I suspect they will want to keep it that way rather than return to squalor.
How to evaluate risk on international investments
When I evaluate risk, I like to do so from an actuarial point of view.
The maid I pay a few hundred dollars a month can be trusted with $100 to go and pay the electric bill, I reckon, because the risk is low that an employee has more to gain from taking my money than from staying with me.
In this scenario, my “actuarial loss” might be $5, representing an estimated 5% chance that the maid merely takes my money and absconds with it. It is a more precise way of looking at risk than merely looking at the two outcomes (losing $0 or losing all $100), because it assigns a theoretical loss to every transaction.
While this way of looking at things is certainly esoteric, it is a good starting point for examining risk in an overseas investment.
Not to mention the fact that it’s quite common. Most turnkey real estate investments back out a certain percentage of annual rents for repairs as well as tenant vacancy when calculating a projected income sheet for investors.
In the same way, you can use theoretical loss when investing in overseas markets. On the most broad level, it is reasonable to estimate that only a small number of real properties in the entire world have been expropriated by their respective governments in the last decade. Property rights in most investible jurisdictions aren’t that bad.
So if you were looking at buying real estate in Cambodia, it might be reasonable to set aside $500 of a $50,000 purchase price for “expropriation risk”. If your estimated return is that amount higher than a comparable western world investment, OR if you could obtain some sort of reliable insurance for that price or less, then there is no net risk premium on that deal.
Other forms of risk in international investing are more easily calculated. You know, for example, what your currency conversion “risk” is going in, and there are ways to hedge against currency depreciation in the investment currency if you are worried it will decline against your desired currency.
Overall, the risks of investing overseas can be boiled down to a few main risks that can be easily addressed or priced into your deal. Consider that people in the most far-flung markets are becoming quite wealthy investing in real estate or starting businesses there, and none of these risks are affecting the majority of them.
Chances are, you’ll be just fine, too.