4 Ways to Invest in the European Stock Market explained by professional Forex trading experts the “ForexSQ” FX trading team.
4 Ways to Invest in the European Stock Market
It’s no secret that over the past several decades, a more connected global economy, widespread access to information, and deregulation in the financial markets have made it easier than ever to diversify your investment portfolio without breaking the bank. For many investors, prudent diversification has meant more than just paying attention to balancing asset class exposure or carefully choosing different sectors or industriesin which to make an investment, extending to geographic diversification, as well.
Here in the United States, this has sometimes meant looking beyond the amber waves of grain to the capital markets of other countries and regions with Europe being a particularly attractive choice for many individuals and institutions thanks to the fact that it is home to many of the world’s preeminent corporations; businesses that have rewarded owners with decade after decade of capital appreciation and dividends, such as Unilever in the United Kingdom and The Netherlands, Sanofi in France, Henkel in Germany, and Nestlé in Switzerland.
For those who aren’t familiar with international investing, this begs the question: how, precisely, does one invest in the European stock market? To help provide a broad, general overview of some of the ways different people might approach this task, I’ve put together a list of four primary methods that an investor and, if he or she is working with an asset management company or wealth advisory firm, his or her portfolio manager or financial advisor, might go about achieving the objective of adding foreign stocks from across the Atlantic to a well-constructed basket of holdings.
The first way you might invest in the European stock market is by purchasing shares of European stocks directly. This method is the most direct and, usually, the least familiar to American investors who have only owned domestic securities. For the sake of illustration, let’s imagine that you decide you want to own shares of Chocoladefabriken Lindt & Spruengli AG in Switzerland.
Lindt, one of the world’s largest chocolate companies, has extensive operations around the globe and owns everything from its flagship Lindt chocolate brand to Ghirardelli, Russell Stover, and Whitman’s; all names with which most Americans are familiar after a lifetime of exposure and enjoyment. While Lindt has a dual class share structure, the primary stock held by the controlling family trades on the Swiss Exchange, has voting rights, and was last quoted at 67,150 CHF per share. In U.S. Dollar equivalents, that is approximately $69,313 per share at current exchange rates.
At this point, the specifics of how to go about buying Lindt shares differ depending upon the brokerage firm you are using to execute your trades. But for a vast majority of retail investors, it is typically going to involve calling the broker’s equity trading desk on the phone so an actual trader can walk you through the trade. They will handle exchanging your U.S. Dollars for Swiss Francs for settlement, charging a spread, and then tell you the final execution price along with the commission, which will usually involve an additional commission for the local broker in Switzerland with which your broker has a relationship.
When the shares appear in your brokerage account, they will be shown without a ticker symbol (or, at least, will have a ticker symbol that cannot be traded online). The shares will also be shown in the U.S. Dollar equivalent, not the actual Swiss quoted price, meaning they can appear to fluctuate wildly even if they haven’t actually changed quoted value on the Swiss stock exchange because the custodian, which is also likely to be your broker, is telling you what the stock would be worth if you sold the position and converted the resulting Swiss Francs back into U.S. dollars.
Equally as important, any dividends received in Swiss Francs are going to be automatically converted back into U.S. dollars, net of a spread for the currency translation, and deposited in the brokerage account. Foreign taxes to the government of Switzerland will also be withheld, usually at a rate of 35 percent unless you go to the trouble of filing out a specific set of paperwork that claims your right as an American citizen, under a tax treaty between the United States and Switzerland, to opt for the lower 15 percent foreign dividend tax withholding rate.
Note that in rarer cases, your custodian might be able to show the quoted value of the Swiss shares in Swiss Francs, and allow you to hold multiple currencies in your account so that dividends arrive in Swiss Francs, too.
One drawback to this method of investing in European stocks is that it requires investing at least several thousand dollars per transaction for the added commissions and expenses to make sense. You’ll also want to consider prioritizing buy-and-hold investments because the currency translation costs make switching between positions more expensive.
The second way you might invest in the European stock market is by purchasing shares of European stocks by acquiring American depository receipts. Another way to invest in the European stock market is to buy foreign stocks through American Depository Receipts (ADRs). While I’ve written about these many times in the past, the short version is this: an ADR depository bank, usually a subsidiary of Bank of New York Mellon, Citigroup, JPMorgan Chase, or a similar financial institution, purchases a large block of foreign stock directly. It then puts this foreign stock on its books and issues securities representing ownership of it, with those securities trading in the domestic market, usually on the Over-the-Counter (OTC) market so individual investors can buy and sell shares just as they might a domestic stock—go online, enter the ticker symbol, review the trade, and submit it to your broker. The difference is that the ADR depository bank collects any dividends, converts them to U.S. Dollars, distributes them to the ADR owners, and then charges small ADR fees in exchange for all of the work it does.
Understanding ADR fees is important. Read this overview to learn what to expect from ADR Fees and Your International Stock Investments.
Often, the ADR depository bank will handle foreign tax treaty filings, too, so the lower 15 percent withholding rate will be taken from dividends rather than the higher 35 percent but you can’t always count on that. Sometimes, ADR are sponsored by the foreign company itself, in which case the ADR will have better transparency and submit certain regulatory filings that it otherwise would not have to submit. In other cases, the ADR is not sponsored by the company but, instead, was created because the ADR custody bank thought there was a market for the security and that it could generate fee income by offering access to the stock.
One challenge when dealing with ADRs is that many financial portals don’t specify if they are reporting the dividend, and the dividend yield, based on the gross pre-tax dividend, as is done with domestic securities, or on the net-of-tax dividend after foreign dividend withholding (and if the latter, at which rate). This means you need to make some adjustments to arrive at an apples-to-apples dividend comparison. Another drawback is that ADR programs might be modified or change in ways you neither anticipated nor like. On the other hand, a nice feature of ADRs is that you can usually shatter them and take possession of the underlying foreign stock if you decide you’d rather own it, instead. This might involve paying a fee to either, or both, your broker and the ADR depository bank.
A real-world example of a popular ADR can be found by looking at ticker symbol NSRGY. These ADRs are issued by Citibank, which acts as the ADR depository bank by holding the actual Nestlé shares that were issued and that trade in Switzerland.
A third way you might invest in the European stock market is by purchasing specialized mutual funds and ETFs. This methodology for investing in European stocks is particularly useful for smaller investors without a lot of capital.
By investing in mutual funds or exchange traded funds (ETFs) that restrict their components to companies headquartered, or which do a large percentage of business, within European countries, you can get the benefits of widespread diversification at a lower cost than you otherwise might be able to achieve by attempting to build the positions directly. For example—and keep in mind that this is by no means investment advice but merely an academic illustration meant to show you how some of these securities work—take a look at ticker symbol VGK, which is the Vanguard FTSE Europe ETF. This pooled structure tries to track the performance of the FTSE Developed Europe All Cap Index, which includes stocks of companies that are located in Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, The Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom. At the time I write this, the largest 10 holdings are Nestlé, Royal Dutch Shell, Novartis, HSBC Holdings, Roche, Unilever, British American Tobacco, Total, BP, and Bayer. The expense ratio is 0.10 percent. The 12-month dividend yield is 2.72 percent.
It’s not all peaches and cream, though. Investing through a pooled vehicle such as an index fund, whether structured as a traditional mutual fund or exchange traded fund, comes with downsides. On one hand, you often have significant unrealized capital gains that are lurking in the portfolio. Under a lower-probability scenario, there exists a series of events that could lead to you paying substantial taxes on someone else’s past gains; a technical point that most investors don’t even realize exists with funds. Perhaps more pressing is the fact that you have to take the good with the bad, including dealing with the underlying sector and industry weightings of the fund portfolio. For example, the aforementioned Vanguard FTSE Europe ETF has more than one-fifh of its assets invested in financial service firms. That is a meaningful amount devoted to one area of the economy and one that is likely to have a lot of correlated risk.
A fourth way you might invest in the European stock market is by acquiring ownership in domestic companies with significant international sales and profits. There can be a tendency for investors, particularly those who are new to investing in common stocks, to mistakenly associate a company with the country in which it is headquartered. There are a good chunk of firms right here in the United States for which a significant minority, and, in some cases, a substantial majority, of sales and profits originate internationally—firms such as The Coca-Cola Company, Procter & Gamble, Johnson & Johnson, and Philip Morris International come to mind immediately. In fact, the U.S. is quickly approaching the point at which half of the sales generated by the S&P 500 arise from activity outside of the United States. In 2016, Europe accounted for a bit more than 8 percent of the revenue of the S&P 500, or $1 out of every $12.
This is to say that by investing in domestic blue chip companies, you very well could be investing in Europe already without realizing it.
4 Ways to Invest in the European Stock Market Conclusion
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