Faraway fields are greener for hungry investors

Many Irish buyers are actively investing in overseasmarkets as an alternative to the shrinking Dublin exchange, writes Peadar Browne

Through accident more than design, the most widely held share in Ireland is not listed on the Irish Stock Exchange.

Something in the region of half a million Irish people are shareholders in Vodafone, the London-quoted mobile phone giant, as a consequence of its takeover of Eircell two years ago.

The small size of most people's holdings and the even smaller size of the dividend cheques means that this phenomenon has gone pretty much un-remarked upon.

But with the departure from the Irish Stock Exchange later this year of Jefferson Smurfit Group, another significant tranche of Irish investors will find themselves holding foreign shares by default. Smurfit shareholders will get one share in Smurfit Stone Container Corporation for every 16 Smurfit shares they own as part of the takeover of the group by Madison Dearborn Partners.

The Eircell and Jefferson Smurfit shareholders may not have had much of a choice in the matter, but many other Irish investors are actively investing in overseas markets as an alternative to the shrinking and illiquid Dublin exchange.

This was highlighted by the significant Irish interest in the flotation of Deutsche Telekom by the German government.

European, American and British markets may offer more opportunities than the domestic one, but investing overseas is not without its problems, the foremost of which is currency risk.

By and large, dealings in companies listed on foreign exchanges take place in the currency of that country.

As a result, Irish investors may make profits on their foreign shares and at the same time incur losses on the currency in which they are traded, should that currency lose ground against the euro.

Apart from this obvious risk, there is also the additional headache of managing a portfolio across several markets and in more than one currency.

To get round this, most brokers offer investors packages whereby the investor can maintain a single account through which his or her money will be invested in the shares of companies in different countries. The theory is that the various exchange rate fluctuations balance out over the course of the year.

Significant currency-related losses are not a common occurrence, according to Mr Martin Kane, director of trading execution business at Goodbody.

"Most clients don't have a way of hedging such currency losses," he says. "But over the course of a year there will be high single or low double-digit growth either way and currency fluctuations won't affect that too much."

Further considerations for investors putting their money into foreign shares include regulatory policies, as dictated by government agencies, and their effect on companies.

Also, political stability, or its absence, in different countries can have a serious impact on company valuations and, therefore, share prices.

Company practices are also an important factor, as evidenced by the demise of WorldCom and Enron when improper accounting procedures came to light.

Apart from foreign exchange risk, the other big disincentives to investing in foreign shares is the more complex tax treatment of both income and capital gains. Irish residents must pay tax on dividends from shares, be they foreign or not, although non-residents may apply for exemption.

The tax is called encashment tax and is usually deducted by the broker as dividend withholding tax (DWT) and paid directly to the authorities. Irish DWT or encashment tax is the standard rate of income tax, currently 23 per cent.

Dividends from foreign shares will usually also attract a local withholding tax.

To avoid unfair double taxing of dividends, the Government has a number of double taxation agreements with different countries. Under these schemes, a credit in respect of the foreign tax deducted is granted against the Irish tax liability. Therefore, Irish withholding tax is paid only on the net gain.

There are a number of complicating factors regarding dividend income from UK and US stock. There is no encashment tax on sterling dividends from British commercial companies. While in the case of US dividends, tax must be deducted at the Irish standard rate without any credit for the 15 per cent US withholding tax. There are several exemptions available for charities, amateur sports organisations and in other special situations.

Encashment tax and DWT are not final taxes. Irish investors must also declare earnings from shares and pay income tax on them at their marginal rate. In addition, any increase in the value of the shares is subject to capital gains tax when realised.

Investors thinking of dipping their toes in overseas markets, and US markets in particular, should bear in mind that the dynamic in these markets is less focused on providing income streams to shareholders.

Traditionally in Ireland and the UK, shares provided an income to investors via dividends paid out of profits. US investors are more focused on growth and capital gains.

"The situation is different in the US and in Europe. In the US, share buy-backs or re-investment of profits is common. Share buy-backs are a means for corporations to use up cash surpluses," according to Mr Kane.

Investors who want stocks that will produce a yield should look to the UK and Ireland, says Mr Kane. "Historically, there has been a bias towards Irish and UK shares but recently there has been a shift to the US more so than Europe," he says.

He suggests that the main reason is that it is easier for the Irish investor to relate to US companies by name and there is more chance that they will know a little about the company.

There are also "logistical difficulties" involved in investing in Europe, particularly the fact that there are a number of disparate exchanges and currencies and settlement companies. This drawback is compensated by the lack of currency risk in investing in other euro-zone states.

Share transactions must be processed by settlement companies, which collect all the information on sales and handle the transfer of certificates and other administrative issues. Currently there are a number of companies operating an "expensive system" in Europe, according to Mr Denis Crowley, marketing manager at stockbrokers Fexco.

"Because there is a third party involved," says Mr Kevin Petley, head of private client settlements at Davy, "there are extra costs." Fexco clients predominantly deal in US shares which are still very attractive to Irish investors.

"There is increased interest despite slightly weaker earnings," according to Mr Crowley. "Overall, what we're finding is that action in the markets, that is the number of trades, is down. Yet two out of three of our deals are purchases, so for every one customer selling, we have two customers buying shares."