Open Markets be Damned: Mutual Funds May Still Offer Greatest Global Equity Access
June 18, 2007
Even if the Securities and Exchange Commission were to eliminate all restrictions on cross-border trading, retail investors' best bet for access to foreign markets might still be the good-old mutual fund, said panelists during a roundtable discussion in Washington last week hosted by the Securities and Exchange Commission.
The event focused on how to make foreign securities more accessible to U.S. investors, and U.S. investors more accessible to broker/dealers overseas.
"The low-end of retail should probably not touch anything other than a mutual fund," said Alan L. Beller, a partner with New York-based law firm Clearly Gottlieb and a former director of the SEC's division of finance. Loosely defined, low-end is a quarter-million or less to invest, Beller said.
Against the backdrop of maturing foreign exchanges, mergers between domestic and foreign exchanges such as that of the New York Stock Exchange and Euronext and a surge of initial public offerings occurring overseas, this year, the SEC expects to introduce guidelines for how U.S. investors might access foreign capital markets. The guidelines will likely limit the markets available for direct investment to those considered to have "comparable" standards to the rules governing exchanges here.
For retail investors, the major benefit would be the ability to diversify their portfolios, without the rigmarole of obtaining American Depository Receipts or paying a broker who then must go to another "chaperone" broker at a non-U.S. exchange, said Roberta Karmel, a professor at Brooklyn Law School and former SEC commissioner and public director of the NYSE.
But even if Joe six-pack could buy Mongolian stocks from the comfort of his living room by punching a few buttons on his laptop, the best, most efficient vehicle to diversify might be a tried-and-true mutual fund or an edgy ETF, others said.
For one thing, dealing with foreign exchange means dealing in a foreign currency, and there is always a cost to conversion. Like anything, consumers save when buying in bulk, and institutional investors with billion-dollar funds typically get a better rate.
For another, different jurisdictions have different rules and taxes. The London Stock Exchange, for example levies a stamp tax, said Stephen E. Bepler, director and senior vice president at Capital Research and Management, the Los Angeles-based investment advisor to the American Funds.
Companies like Capital and Vanguard have their own traders licensed and dealing directly at exchanges overseas. But smaller fund companies that might not be as flush with cash, and that need to, like any other investor, pay a chaperone broker in addition to the domestic trading partner, would benefit from open access to foreign markets, he said.
Even if the need for chaperones is obliterated, fund companies with their own traders will not lose their edge, as increased competition will lead to better opportunities for best execution, Bepler said.
Still, for investors large and small alike, the real cost is in custody and clearing, said Chris Concannon, executive vice president of transaction services at Nasdaq in New York. Again, economies of scale dictate that the more you trade, the less you pay.
But if increased competition does squeeze the costs of execution, custody and clearing, there is no guarantee that that savings would benefit the retail investor, anyhow, said Harold Evensky, a certified financial planner and principal at Evensky & Katz in Coral Gables, Fla.
As for the pent-up pressure to access foreign stocks among retail investors, Evensky said he doesn't feel any. "The wealthy and mass affluent are not clamoring to invest individually in foreign stocks," he said.
Although 84% of the initial public offerings (IPOs) in 2006 were issued on exchanges outside of the U.S., there is no shortage of opportunity to get a piece of the global action at home, Evensky said.
Fifteen percent of U.S. mutual funds are funds of international stocks, he said, and new products are increasingly following the global trend. Thirty percent of all U.S. mutual funds registered last year and 40% of ETFs were international funds.
"There is absolute access for the retail investor," Evensky said.
As for accessing overseas IPOs, retail investors wouldn't have a chance, said Christopher Amato, of Arlington, Va.-based E*Trade. Allocations are going to go to the institutional investor seeking one million shares who is in the market daily, not the retail investor who wants 100 shares and who trades three times a month, he said. Those who invest through funds, he said "get to ride the coattails of institutional clearing houses. They actually get cheaper access," said Amato. E*Trade operates in 42 markets, but offers direct access in six.
Mutual funds registered in the U.S. also benefit from home-court advantage, said Richard G. Ketchum, chief regulator of the NYSE. Investors will typically feel more comfortable with companies they know and that are regulated by entities they trust, he said. Fund companies can leverage their international holdings this way to compete, he said.
For these reasons, it makes the most sense to limit foreign access to certain institutional or pre-qualified investors, said David Grayson, managing director at Auerbach Grayson, a brokerage in New York.
Even if the SEC decides to open all markets to all investors, accessing them directly is best left to large investors with $5 million or more, said James R. Allen, chairman and chief executive at Hillard Lyons, an investment firm in Louisville, Ky. For the mass affluent, or those with between $250,000 and $1 million, Allen said, "the mutual fund concept makes great sense."
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