Where in the world should you invest?

Many people dream of retiring at age 50, but 11 years ago, Keith Betty actually did it. The former chemist, now living in Lethbridge, Alta., credits much of his success to avoiding debt (he hasn’t had any since 1980) and a disciplined, diversified investment strategy. He didn’t have a big pension at work, so he knew that he would have to supply more than 80% of his retirement income from a rock-solid investment portfolio of his own design. To assemble it, he studied the markets, stocks and mutual funds. He soon came to the conclusion that putting all his money into Canadian and U.S. stocks was crazy. “I need my investments to produce income I can live on,” he says. “If I concentrate too heavily on one thing and I’m wrong, it could be a disaster.”

That’s why Betty has become a big fan of global investments. He invests 10% of his portfolio outside of North America—though others suggest that your international investments can account for 20% or even 30% of your holdings. There are many ways to do it. You could buy stocks in foreign markets, or choose mutual funds with exposure to different parts of the world. But because of their low fees and simplicity, Betty prefers using exchange-traded funds, or ETFs. They offer a broad exposure to the global economy—something he thinks is essential for small investors. “Canada is a mature market. It’s not always going to grow that fast.”

If you’re not familiar with ETFs, it helps to think of them as being like mutual funds that automatically track major market indexes in each country, such as the S&P 500 in the U.S. or the S&P/TSX Composite here in Canada. But there is a difference. You buy them like stocks on a stock exchange and they charge rock-bottom fees. If you’re into MoneySense’s Couch Potato Portfolio then you probably already own several.

Once you’ve decided on the method you want to use to invest globally, you’re ready for the big question: where in the world should you invest? The globe is a big place, and faced with dozens of countries to choose from, it’s easy to get overwhelmed. Luckily, MoneySense is here to help. We’ve done the dirty work for you and crunched reams of hard data to come up with the top markets to invest in today.

There are many potential considerations to take into account, but we’re bottom-up investors so we started with valuation first and focused on the numbers. Our opinions about a particular country or its people don’t factor into our initial considerations. What we want to know is whether a stock market is selling at a bargain price and shows strong momentum.

When investors start out, they usually stick close to home, but some of the strongest growth in the world comes from beyond the largest Western markets. Emerging players grow faster and they have lots of room to catch up. Hardly a day goes by without some mention of China’s rapid rise on the world stage. Similarly, places like Brazil, which has been blessed by newly discovered oil deposits, are whetting the appetite of capitalists.

It’s easy to see why investors are keen on China. The world’s most populous nation is growing its GDP by more than 8% annually, and it can grow even more before pulling alongside the developed world on a GDP-per-capita (i.e. GDP per person) basis. Indeed, China’s future looks bright and it is one of our top momentum candidates.

We know too that some investors are a little leery of emerging economies like China. That’s why we split the world into developed and emerging markets. We can then highlight good opportunities to investors seeking relative safety in the developed world while also catering to those who are keen on the excitement of the emerging world.

What’s the difference between a developed and emerging market? That’s a good question and it’s open to some debate. Roughly speaking, the developed world tends to represent industrialized countries with good legal and political systems. Such countries have been through their heady growth phase and now tend to be slower growers. On the other hand, the emerging markets generally start from a lower base but often grow rapidly as they play catch up to the rest of the world. However, their institutional systems may need some work.

Because there tends to be a big difference between emerging and developed markets, we evaluate them separately. We first focus on the developed world and then explore emerging markets. But in both cases we evaluate countries (as represented by their country-specific ETFs) in two ways. First, we look for those that represent good values relative to their fundamentals. These are value markets which appeal primarily to investors with a longer-term outlook and a penchant for lower risk situations. Second, we highlight markets with momentum. Here we seek strong recent return patterns that appeal to action-oriented investors.

Countries on sale

Value investors like to rummage through the bargain bin for overlooked gems. When it comes to whole countries, value can often be found in slower-growing nations that may be viewed as boring. But this lack of excitement often leads to modest prices which more than make up for a slow growth rate. Indeed, with a sufficient handicap, even the slowest tortoise can beat the fastest hare.

On the fundamental side, we like countries with low price-to-book-value ratios. In the case of country-specific ETFs, this ratio is determined by summing up the current price (market capitalization) of each company in the index and dividing by the sum of each firm’s net worth (assets less liabilities). We also like to see low price-to-sales ratios, which provide a good secondary check on value. We arrive at our list of top 10 value countries by combining both low price-to-book-value and price-to-sales grades.

Go-go markets

When it comes to momentum, we want go-go markets with strong recent performance trends. The idea is to hitch a ride with the hot money while times are good. But momentum investors must be willing to move on to the next big thing with alacrity. Active traders favour the momentum approach but even buttoned-down academics are coming around to see its merits. Just be warned, the ride can be a wild one.

We rank each market primarily by its most recent six- and 12-month price history. High marks are given to those country-specific ETFs with the best combination of both.

Where you should invest

So what did we come up with? Have a look at the world map and accompanying table above and you’ll see the top 10 countries to invest in by value and the top 10 by momentum. In each list, the first six are developed countries, and the remaining four are emerging markets. We include more developed countries because there are more to choose from, and we think many investors prefer stable regions.

In the value list, we found that Europe dominates the developed countries. Fully five out of six hail from the continent. Italy (ticker symbol NYSE: EWI) leads as the best value with an average price-to-earnings ratio of 11.2 and a low price-to-book-value of 1. Remarkably, Italy is also a top momentum player with a blistering six-month return of 85%. Belgium (NYSE: EWK) is second on the value list, but it’s fairly concentrated. Big brewer Anheuser-Busch represents a whopping 24% of the ETF and ten stocks make up 73% of its portfolio. Germany (NYSE: EWG), France (NYSE: EWQ), and Austria (NYSE: EWO) follow. Long ailing Japan (NYSE: EWJ) rounds out the top developed markets that seem to be selling at bargain-basement prices right now. Just be warned, the land of the rising sun’s stock market peaked decades ago and it has languished since then. That makes Japan a contrarian selection.

Value is a relative thing when it comes to the emerging markets. Indeed, on an absolute basis the best values are to be found in the stodgy old world. But Thailand (NYSE: THD) gives the old fogies a run for their money. A low 0.85 price-to-sales ratio make the land of a thousand smiles quite attractive. It also sports strong momentum characteristics and it is one of only two countries, along with Italy, to make it as both a top value and top momentum pick. Close behind, the island nation of Taiwan (NYSE: EWT) garners very strong value marks. Israel (NYSE: EIS) and South Korea (NYSE: EWY) round out the best values in the emerging world even though both are located in rather dangerous spots on the globe.

On the momentum side of the ledger, Spain (NYSE: EWP) is on fire, topping the list in the developed world. But Singapore (NYSE: EWS) is just a fraction behind. These countries are followed by Sweden (NYSE: EWD) and Australia (NYSE: EWA) which are also nearly tied. Hong Kong (NYSE: EWH) and Italy (NYSE: EWI) round out the top six. But the huge bounce off the winter lows means that it’s hard to pick and chose between the best momentum markets. They are all packed close together in terms of recent returns.

Emerging market momentum is led by Thailand (NYSE: THD) with Turkey (NYSE: TUR), China (NYSE: FCHI), and South Africa (NYSE: EZA) following close behind. Of the bunch, China is perhaps the most glamorous. But glamour comes with a high price in this case. China has relatively poor value characteristics and could disappoint when its momentum flags. Keep a keen eye out for signs of a slowdown, but returns could be quite generous until then.

There be dragons

When heading out on the high seas of finance, potential dangers abound. Political instability often hits investors hard. In some emerging markets, your hoard could be plundered or confiscated on a moment’s notice—sometimes by the government. Even in more developed regions the legal system may be capricious. (For instance, hardly a day goes by without some jackpot enriching lawyers in the United States.) When it comes to investing internationally, the world is full of opportunities and risks to consider. So, pause, reflect, and investigate before diving in.

Currency fluctuations are also a big worry. We’ve all seen the local impact of exchange rates across the 49th parallel. Depending on the rate, people flood over for a little cross-border shopping to pick up bargains. But those varying rates also impactinvestors when they buy stocks outside Canada. When the loonie gains ground, those who already own international equities often see the value of their holdings fall in Canadian dollar terms.

You can hedge (or try to insure against) currency risk if you want to. Indeed, you can buy ETFs like the iShares Canadian MSCI EAFE international index fund (TSX: XIN) that do the currency hedging for you. But hedging costs money, which adds up over the long term, and currency fluctuations tend to even out over very long periods. That’s why some investors, who can stomach the short-term risk, simply forego hedging.

You also have to consider the stakes involved. How much of your portfolio should be dedicated to international markets? That depends on your risk tolerance. Most Canadians allocate relatively little to stocks beyond the U.S. and Canada. Say between 20% and 30%. Emerging market exposure is typically even smaller and most investors should stick to 10% or less.

You should also be sure to take on risks that you can handle. The recent market downturn highlights the magnitude of the potential losses for stock investors. Just take the Russia ETF (NYSE: RSX) as an example. It hit a high of $59.58 in May of 2008 and bottomed out at $10.34 less than 12 months later. That’s a peak-to-trough decline of 83%. Since then, the index has gone on to more than double from its lows, but it’s still well down from the peak. If you can’t handle such losses, you should probably stay away from the emerging markets altogether. But even the developed markets aren’t immune to steep declines. Just talk to investors who have held onto their Japanese stocks since they peaked in the late 1980s. You’ll hear a sorry tale because the market still isn’t close to recovering.

We like investing internationally but, before heading overseas, make sure you know what you’re getting into. Investigate the country you’re interested in, explore its markets, and study the specific investments you want to make. If you’re an ETF investor you’d do well to visit the ETF’s website, read any associated regulatory fillings, and make sure that the investment is a good fit for you and your portfolio. m

decades ago and it has languished since then. That makes Japan a contrarian selection.

There be dragons

Currency fluctuations are also a big worry. We’ve all seen the local impact of exchange rates across the 49th parallel. Depending on the rate, people flood over for a little cross-border shopping to pick up bargains. But those varying rates also impact investors when they buy stocks outside Canada. When the loonie gains ground, those who already own international equities often see the value of their holdings fall in Canadian dollar terms.

You also have to consider the stakes involved. How much of your portfolio should be dedicated to international markets? That depends on your risk tolerance. Most Canadians allocate relatively little to stocksbeyond the U.S. and Canada. Say between 20% and 30%. Emerging market exposure is typically even smaller and most investors should stick to 10% or less.