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Whether to invest in China depends on how well the country will survive its current addiction to exports, says Tyler Mordy, director of research at Hahn Investment Stewards & Co.Jeff Bassett/The Globe and Mail

When it comes to investing, we all have a home-field advantage.

We're familiar with the Canadian investment climate and the factors that feed into it – the politics, economy and companies – but move outside Canada and perhaps the United States, and that familiarity begins to dissipate. Take a step even farther afield, into emerging and so-called frontier markets, and most investors are on even shakier ground.

"It is always more comforting within our own borders, but we may be missing out on opportunities," says Serge Pépin, vice-president of investment strategy for Bank of Montreal Global Asset Management.

"To really achieve diversification in your portfolio, you have to go beyond Canada's borders," says Eric Kirzner, a professor at the University of Toronto's Rotman School of Management.

So how do you choose where and how to invest?

Prof. Kirzner suggests starting with a broad approach. "Where do you think the future lies – before getting into mathematics and metrics?" The answer, he says, is countries such as China and India, which "clearly are going to represent the future of the world."

From there, investors can look at exchange-traded funds (ETFs) or funds that concentrate on the countries in which they have confidence.

When you consider a country, look beyond growth, says Tyler Mordy, director of research at Hahn Investment Stewards & Co., which specializes in ETF portfolios.

He suggests that investors look at economic indicators such as net national savings rates, productivity growth, the five-year expected current account deficit or surplus, the government's budget deficit or surplus, and debt as a percentage of gross domestic product.

It's important to consider all of a country's economic fundamentals, Mr. Mordy says, but investors tend to place far too much emphasis on growth.

The problem, he says, is that investors pile on in countries known for high growth, and they end up bidding up prices. "It's very similar to any type of sexy stocks ... they overpay for growth."

As well, Mr. Mordy says, a lot of growth in China and India is driven by exports, which is a long-term problem because Western economies won't be able to absorb that supply of consumer goods forever. "The key question for international investing in those places is which countries can transition to that postmercantilist world, where they're no longer hooked on exports."

Investors shouldn't focus solely on economic indicators, either, advises Marc Cevey, the Toronto-based chief executive officer of HSBC Global Asset Management (Canada) Ltd.

Investors often forget about financial markets, which factor in everything from political certainty to economic factors, even discounting future developments. "All factors are relevant in deciding where to invest. They are however not always helpful in deciding when to invest. ... Financial markets are really viewed through your windshield, while economic indicators represent the rear-view mirror," Mr. Cevey says.

Other factors are at play, too. He cites the example of Britain and Canada, which both have triple A ratings but have significant differences in their fiscal and economic fundamentals.

The fiscal profiles in many emerging markets are stronger than those of some developed countries, Mr. Cevey says. "They're high-growth but that does not mean they're still high-risk," he says. For example, China has a debt-to-GDP ratio that's marginal – much different from the deteriorating fiscal balances in Europe.

It's a point that Mr. Mordy makes as well, citing a study by his firm that looked at what he calls the G5 – the United States, Japan, Britain, Germany and France – and comparing them to all emerging markets. Both groups account for about 40 per cent of the world's GDP, but the G5 has about 70 per cent of the world's sovereign debt compared to about 10 per cent for the emerging markets.

Mr. Cevey says investors buying foreign bonds have to consider the country's currency most of all. "It's not about the yield, it's about the total return, and that is represented by the currency."

Mr. Pépin says investors who are considering developed markets, such as Europe or developed Asia, should concentrate more on the companies and sectors than the countries. You can diversify your portfolio by looking for companies abroad in sectors that aren't well represented in Canada – health care, for one, and certain kinds of technology.

"For the developed markets, borders don't really matter that much," Mr. Pépin says. Take Japan. The economy there is in its third recession over the past several years, but that shouldn't stop you from considering Toyota or Honda as an investment, he says.

However, a country's fundamentals play a more important role if a company isn't a multinational and operates only within its borders.

As for emerging and frontier markets, Mr. Pépin says they do offer additional returns, but you have to be comfortable with higher risk. Investing in some of these markets requires considering everything from political stability to economic indicators, he says. Currency, he adds, is also a crucial factor – some are not liquid and can be quite volatile, which can have a huge impact on returns.

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