Securities Regulator Alerts Investors To Global Market Risks

James J. Eccleston, esq.

he National Association of Securities Dealers (NASD) has issued an Investor Alert regarding global market risks that can affect all investments. Let's examine those global market risks.

Preliminarily, investors must understand that when they own shares in, or debt issued by, a particular company, they always are exposed to what are called "non-systematic" risks. These risks include management risk and competition risk, and they can affect the company's growth, revenue and earnings. Likewise, investors who own bonds are exposed to credit or default risk, which is another type of non-systematic risk particular to the issuer of that bond.

The NASD's Investor Alert, on the other hand, relates to "systematic risks", which involve factors that affect the overall economy or securities markets. Systematic risks affect all investments no matter how solid the fundamentals of a particular company happen to be.

What are these global market risks? First, the NASD discusses interest rate risk. As interest rates rise, the price of previously issued bonds falls. The reverse also is true, so that if interest rates fall, the price of previously issued bonds rises.

Second, the NASD warns of inflation risk. Inflation risk, also known as "Purchasing Power Risk", is "the risk that general increases in prices of goods and services will reduce the value of money, and likely negatively impact the value of investments." There also is a correlation between interest rate risk and inflation risk, because interest rates generally move in the same direction as inflation. During periods of low inflation, investors will find bonds paying correspondingly low interest rates. The NASD cautions that, during such a low interest rate environment, investors may not want to purchase low-grade bonds, paying higher interest rates, because such low-grade bonds carry much higher default risk.

The third global market risk is currency risk. To purchase or sell stocks or bonds issued by companies outside the U.S. or funds that invest in international securities, money needs to be converted to a different currency. When that happens, the NASD warns that "any change in the exchange rate between that currency and U.S. dollars can increase or reduce your investment return."

Fourth, liquidity risk. This is the risk that an investor may not be "able to buy or sell investments quickly for a price that tracks the true underlying value of the asset." It also is possible that there will be no market at all for an investment, making it illiquid altogether. The NASD warns that foreign markets pose particular liquidity risks such as the size of the foreign market (smaller markets increase liquidity risks) and, in certain countries, restrictions on investments purchased by foreign nationals or repatriating them. The NASD states that, as a result, "you may (1) have to purchase securities at a premium; (2) have difficulty selling your shares; (3) have to sell them at a discount; and (4) not be able to bring your money back home."

Additional risks that the NASD discusses are: sociopolitical risk; country risk; and legal remedies risk.

How can investors protect themselves from global market risks? While investors never can avoid such risks entirely, the NASD advises investors to do two things. First, diversify. In diversifying, investors should invest in different products, sectors, regions and countries, as well as in the length of the holdings (short term, intermediate term and long term). Additionally, the NASD suggests that investors perform their due diligence. The NASD writes that, "If you are thinking about investing in foreign securities, learn as much as you can about the market history and volatility, socio-political stability, trading practices, market and regulatory structure, arbitration and mediation forums, restrictions on international investing and repatriation of investment."

That's good advice for investors considering a global approach to investing!

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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.