Risks and Benefits of Foreign Investments

by Raymond Nicholas

On May 6th, 2014, Alibaba, a Chinese E-commerce goliath filed its IPO with the United States Securities and Exchange Commission (“SEC”), in what many economists predict could be the largest or one of the largest initial public offerings in United States history. Alibaba currently controls eighty percent of China’s E-commerce market and is worth more than 100 billion dollars.

The Alibaba IPO presents numerous risks investors should consider before investing in foreign equities. According to a report by William Alden of the New York Times, notable risks of foreign equities include: 1) corporate structure; 2) U.S. Securities laws being less stringent on foreign companies; and 3) increased market volatility. Alibaba is also subject to economic downturn in the Chinese market, which would adversely affect its success in the US market. The SEC, U.S. News, and Financial Industry Regulatory Authority (“FINRA”), all warn investors of volatility in foreign markets directly related to political instability.

China has a developed economy; however, the Chinese Government heavily regulates the economy and Internet infrastructure, presenting another risk to investors considering investing in foreign companies. Government regulation varies by country, making it difficult to accurately gauge the success of a foreign company in a U.S. Market. Finally, foreign companies are subject to fewer causes of action in U.S. courts due to complicated jurisdictional issues.

Contrary to the risks of international investment, there are advantages to investing in foreign companies. A report from T. Rowe Price that some international companies are growing faster than their U.S. counterparts. Alibaba appears to be one of them. Many economists, including Rick Ferri of Forbes, state international investments are key to a well-diversified portfolio, and recommend a 70% to 30% ratio of U.S. stocks to foreign stocks. The advantages and disadvantages listed here are by no means all inclusive. Investing in foreign companies requires consideration of factors not relevant in domestic companies. Alibaba’s IPO illustrates the benefits and disadvantages of investing in foreign companies. Most importantly, the Alibaba IPO reaffirms the importance of due diligence and thorough research. It is crucial to sift through the hype surrounding an investment to ensure safe, well thought out investing.