Silly Idea of the Day: Opening Foreign Brokerage Accounts

Abnormal Returns rarely criticises the stories it features in its invaluable daily linkfest. But today's an exception:

Color us skeptical that individual investors should be opening brokerage accounts around the world. (WSJ.com)

Boy are they right to be skeptical. Armed with 1500 words of prime WSJ real estate and a new book to plug, Jeff Opdyke informs us that retail investors can and should buy foreign stocks abroad. "Opening brokerage accounts in places like Hong Kong, Egypt, Australia and even Vietnam is generally no more difficult than ordering a book online," he writes.

Well, yes, and sending money to Sani Abacha's nephew in Nigeria is pretty easy too, but that doesn't mean you should do it.

Investors in the US are used to being protected by the SEC. Their investments might sour, but they pretty much always own what their broker tells them that they own. In the US, it's more or less unheard-of for people to open a brokerage account, fund it, and for the broker to then simply pocket their money while occasionally sending them statements telling them how much money they're making.

Unfortunately, in the rest of the world consumer protections are very different. And even if your broker isn't an outright fraud, the chances are you still don't have anything like the sort of protections offered by the SIPC in the US. Besides, you're going to be paying large transaction costs every step of the way: when you open your account, when you convert your dollars into local currency, when you send the currency abroad, when you buy the stocks, when you receive the dividends, when you convert the dividends back into dollars, when you remit the dollars back to the US, when you sell the stocks, and so on.

On top of that, I think it's pretty fair to say that retail investors simply aren't set up to judge the risks inherent when you layer market risk, counterparty risk, and foreign-exchange risk in the way that Opdyke recommends. The correlations there are complex and dynamic, and even large investment banks have difficulty staying on top of them. Individual investors almost certainly have better things to do than try to judge the relative value of a stock in a country with high exchange-rate volatility to a similarly-priced stock in a country with low exchange-rate volatility - especially when that low volatility is almost certainly the result of an express or implied central bank monetary policy which may or may not change in future.

Opdyke claims to have made good returns by buying a stock in New Zealand in the mid-1990s. He claims that he was "searching for consumer-oriented Pacific Rim companies likely to benefit from Asia's multidecade economic expansion", but I suspect a large proportion of his returns ended up coming from the fact that he inadvertently got exposure to the New Zealand dollar at the same time. In other words, he was just as lucky as he was smart.

Now there is good advice in Opdyke's column, it just happens to be the advice he abjures:

For all the years I've covered financial markets for The Wall Street Journal, I've routinely heard the investment industry counsel that owning individual stocks, much less individual foreign stocks, is not a game small investors like you and I should play. Many pros argue that individual investors should avoid fording the oceans because they haven't got the necessary skills to analyze unfamiliar companies in unfamiliar lands, operating in unfamiliar industries, according to unfamiliar accounting rules and governmental policies.
While Wall Street experts certainly agree with the need to diversify internationally, it's best, they insist, to stick your money in a mutual fund or ETF here in America. If you promise not to hurt yourself, they might suggest you deploy some "play money" in big-name ADRs.

I'm no great fan of "the investment industry". But in this case, they're right.