That’s if you believe a Nobel economist, of course. His crude “experiment” was the start of “modern portfolio theory” decades ago. The downside, however, was that with a reduction of risk came a dampening of profits. So scratch that idea.

How about this? A startling study in the late 1970s showed that owning a portfolio of large U.S. companies with international divisions drops your risk 10% below a domestic stock portfolio. Much better. But that wasn’t the eye-popper…

The study also found that owning stocks in international companies cuts your risk in half…

Take that, “efficiency” theorists! Yet the stuffy professors still tried to refute these results. It was a losing battle, though, as more studies emerged, laden with more evidence that international stocks reduce risk.

But the most startling thing? The studies indicate that adding international stocks to your domestic portfolio may even increase your average profits.

But how do you buy stocks in foreign companies trading in London, Hong Kong, or São Paulo? By investing in ADRs… let me explain.

How to Go Overseas Without Even Getting On a Plane

Let’s say you want to buy shares of an English company, trading on the FTSE-100 index. You’d have to convert your cash to pounds, buy the stock, wait to sell it at a profit, then convert it all back to U.S. dollars.

If the greenback weakened, you’d make a profit on the stock but lose on the conversion!

In a word: Ugh.

This is why the vast majority of investors buy a managed international mutual fund. This allows the “experts” to run overseas with your bag of cash and make the investments for you.

But is this really smart?

As early as the 1960s, some economists confirmed that fund managers can’t forecast stock prices well enough to cover their own expenses, let alone make you a profit. In the end, all economists – regardless of their background – agreed that the performance of a managed mutual fund is worse than throwing darts at a list.

Here’s a better way…

Investing in ADRs: Harness JP Morgan’s Secret Weapon

In 1927, a chain of retail stores wanted to list on the NYSE.

Problem was, all the stores were in England!

Even for JP Morgan (NYSE:JPM) – the greatest investment banker of all time – this one was tricky. But he came up with a solution: He bought a big block of the retailer’s shares on the London Stock Exchange and put them in a trust.

Then he sold shares of the trust on the NYSE. These shares were called American Depository Receipts – or ADRs for short.

The company was Selfridges. And with Americans able to invest in a well-managed foreign company with far less risk, the shares sold like hotcakes. And thanks in no small part to this early access to American money, Selfridges is renowned and still thriving today.

So if you want to toss darts around, you could randomly add 3-7 ADRs to your portfolio – a move that will cut your portfolio risk in half, while increasing your profits.

For example, you can go to www.adr.com and throw darts at companies like Holland’s Aegon NV (NYSE: AEG), China’s Acorn International Inc (NYSE: ATV), or Brazil’s Aracruz Celulose SA (NYSE: ARA).

But randomly picking foreign companies is pretty reckless. Here’s how to invest in international stocks properly…

The Four Advantages of Investing in ADRs

What if you knew which international companies were primed to explode in share price? That’s exactly the kind of profitable information that New Frontier Trader readers get all the time.

So here’s my four-point guide for selecting the best foreign ADRs and how they can roll back your risk, even as they ramp up your returns.

• ADR Advantage #1: International Markets Don’t Move Together:

One of the main advantages that ADRs offer is that stocks in two different countries don’t move together.

When you hit the ground in most foreign countries, it’s a whole new economic, political and cultural landscape.

So even if your U.S. stocks are going down, your ADRs might be rising. Take Argentina’s Banco Macro (NYSE: BMA), for example. You could have bought it on July 6 for $16.34. It’s currently trading around $22.85. That’s a 40% return in just two months.

The New Frontier Tip: Buy at least three different high potential ADR stocks, operating in at least three different international countries.

• ADR Advantage #2: Hardship Breeds Managerial Excellence:

Okay, so what about countries that are chaotic – either economically, politically, or in terms of corruption? Places where managers tread in fear day by day.

Check out Transparency International’s Corruption Perception Index. It’s a good measure of social disarray. The United States has a relatively low corruption score of 18, while Somalia has the highest at 180.

Managers become slothful when business is easy. But imagine trying to do honest trade in a pirate haven like Somalia?!

And how about the BRIC economies – Brazil, Russia, India, and China? The corruption score is 96. In fact, Russia alone scores a whopping 147 on the global “Dewey, Cheatem & Howe” scale. Not even Superman’s x-ray vision would help an economist’s macro analysis.

But intense social disarray breeds the toughest managers, and the companies that rise to the top, despite the chaos, are often the pick of the bunch.

One such firm is Ecopetrol (NYSE: EC). It’s the largest integrated oil company in Colombia. You could have bought it on May 18 for $19.31 per share. By Labor Day weekend, it was trading at $26.41 for a tidy return of 37%!

The New Frontier Tip: Look for outstanding management where Wall Street doesn’t expect to find any.

• ADR Advantage #3: Muddy Waters Hide Big Fish:

Studies have proven that Wall Street analysts are incapable of honestly reporting opportunities in their home market. And they’re even more misleading if you try to follow them overseas.

The analyst’s real job is directing traffic where Wall Street’s CEOs and their boards want order flow to go. If executives need to cash out their options, the analyst’s opinion is suddenly upgraded to a green light.

Frankly, Wall Street doesn’t make a dime helping you find a potential fortune in developing countries.

But there are a few outstanding individuals like Warren Buffett, who are skilled at spotting hidden jewels. So you could just buy Berkshire Hathaway (NYSE: BRK.B).

But we have a better way: Go direct!

Take China, for instance. Getting solid information from this murky, mass-demand economy is like pulling teeth from a shark!

But if you had the edge, you could have bought shares in the massive Chinese Holiday Inn, with more than 500 budget hotels in more than 90 Chinese cities. Had you bought Home Inns & Hotel Management (Nasdaq: HMIN) at $15.19 on May 12, you’d be sitting on an 88.1% gain in just four months.

The New Frontier Tip: Target markets that Wall Street doesn’t want you to understand.

• ADR Advantage #4: Hunt Down Profits That American Conglomerates Can’t Touch:

Foreign companies located in faraway lands that rise to the top of their regional markets are special. By the time the world’s biggest investment banks invite them to become an ADR, they’re pumping out profits like one of J. Paul Getty’s oil rigs.

South America has hidden Copa Airlines (NYSE: CPA) from American investors until just recently. You could have bought the stock for $32.22 on May 27. Today, it’s trading for $43 – a fast return of 33.4%. In addition, the firm’s operating margin is 20.3%. Compare that to margins at Southwest (2.1%), Jet Blue (6.5%), or American (-3.4%).

The Single Best Way for Investing in ADRs…

Each of the returns I’ve mentioned above were recommendations in Alex Green’s New Frontier Trader newsletter. This service gives you an edge over the crowd in grabbing the best gains from investing in ADRs.

And the rest of the track record speaks for itself. This year, the service has closed out nine double-digit winners on international stock positions and six triple-digit winners by playing foreign stock options.

Time after time, history has shown that the best way to combine reduced risk with explosive returns is to invest in overseas markets, where Wall Street doesn’t want you to look.

If you’d like to start enjoying the kind of profits that the New Frontier Trader has kicked out to subscribers, simply check out this report.

It all starts with education,

Dr. Scott Brown

Source: Investing in ADRs: The Most Powerful Way to Reduce Market Risk

Satyajit Das’s book, Traders, Guns & Money, opens with a great anecdote about a meeting with an Indonesian noodle company. The noodle men were “Indonesians of Chinese extraction,” Das writes. “They were part of the infamous ‘bamboo network’ of ethnic Chinese business interests that crisscrossed South East Asia.” The noodle shop was an old business, playing an ancient and humble trade, the kind you find throughout Asia. Sounds like a nice simple business, right? Yes, but…

The noodle company got itself into some trouble. To simplify the story greatly, it basically lost a lot of money using derivatives to bet on dollar-rupiah movements. The loss suffered was, in fact, more than the capital of the company itself. At one point, Das writes: “What this had to do with producing noodles was a mystery.”

Exactly!

Unfortunately, this kind of story riddles the markets today like worms in an otherwise worthy cut of swordfish. There are so many of these incidences and they are ruining companies and investors across the world. It takes a nasty crisis like the one we are in to expose all these things. And the rot is extensive.

I want to share with you three little-reported events and one historical example that all show how pervasive this mindless risk-taking became during the last few years. They would be almost comical if they weren’t true.

First, consider the sad example of several Mexican and South American companies that made, large, company-jeopardizing currency bets. For example, Mexico’s third largest retailer, Controladora Commercial Mexicana (MXK:COMERCIUBC), recently filed for bankruptcy after losing so much money speculating in the forex markets. What does currency speculating have to do with selling tortillas, milk and eggs? Nothing. That’s the point.

Similarly, Sadia (NYSE:SDA), a poultry producer; Cemex (MXK:CEMEXCPO), a cement outfit; and Gruma in tortillas – all lost huge amounts of money on currency bets. Aracruz Cellulose (NYSE:ARA), the much admired pulp giant of Brazil, owes more than $2 billion to its banks for making bets on currencies that went sour. What was once a great franchise has been brought to its knees. It will take years to pay that back and debt payments now make up 40% of its pre-tax earnings.

The second example of mindless risk-taking is the story of so-called “portable alpha.” Apparently, the brain trusts that run pension funds thought this strategy sounded like a good idea. What is it? I still don’t understand it fully. But it basically amounts to a leveraged bet on the stock market. If you lose, you lose big as many pension funds are finding out. So now the Pennsylvania state employees’ pension fund, for instance, will have to take a multi-billion bath on this exotic investment strategy.

As the Wall Street Journal reports: “The stock-market downturn could force the Pennsylvania state employees’ pension fund to make cash payments of $2.5 billion or more to trading partners on Wall Street.” The fund has only $27 billion in total. At least, it had $27 billion.

Several other funds have reported billion dollar losses on portable alpha strategies. I can only imagine how many more institutional investors are in the same boat. The people running these things and advising these people should all find other work.

The third example is so-called “accumulators,” which is another kind of tactic for placing highly leveraged bet on stocks, currencies or commodities. I don’t want to get into the details. It’s so complicated; it would take me a page to explain it. Just know that, like “portable alpha” if you are wrong, you lose big.

And yet all kinds of wealthy individuals and businesses have gotten wrapped up in these things. Accumulator losses are showing up in some unlikely places. For instance, VeraSun Energy Corp. (OTC:VSUNQ), which makes ethanol, filed for bankruptcy in part because of big losses on accumulators tied to the price of corn. Citi Pacific (ASX:CIY), a Chinese conglomerate, lost $2 billion on accumulator contracts linked to currencies.

Billions and billions of dollars lost on nonsense. There was no reason for anybody to buy these things – especially when they clearly did not understand the risks involved. The losses are so bad in Hong Kong that Any Xie, an independent economist, said recently that “Accumulators are ruining Hong Kong.”

I’ll offer one other example of this kind of recklessness that is both a historical and contemporary study: Goldman Sachs.

I just recently finished perusing Charles Ellis’ new history The Partnership: The Making of Goldman Sachs. I was particularly interested in the early history of Goldman Sachs (NYSE:GS). I thought I would come away thinking how Goldman Sachs used to be a simpler business. I thought Goldman’s history would show how it took prudent risks with adequate equity backing those risks. My conclusion would then be that the current crop of leaders at Goldman were just reckless and ruined a franchise that had been around since the 1880s.

In fact, that’s not what I learned at all. From Goldman’s earliest days as a commercial paper specialist it operated with minimal capital. All through its history, it has been a business that took big risks and often took huge losses. That Goldman even exists at all today is something of a financial miracle.

In reading this history, I was struck by how the company found itself in the soup again and again and again. In the 1920s, one of the biggest speculative busts was in investment trusts in which a small amount of capital supported a spider’s web of investments in other companies. Guess who had the biggest blow-up of them all?

Goldman was big in this through a subsidiary called Goldman Sachs Trading Corporation, which basically lost everything for its investors. Ellis writes:

“While all the investment trusts suffered, Goldman Sachs Trading Corporation – because it was so large and so highly leveraged…became one of the largest, swiftest, and most complete investment disasters of the twentieth century.”

The loss to Goldman Sachs itself was enormous. It basically wiped out thirty years of profits and eliminated the “fruits of all the labors of a generation.”

Fast forward to 1970 and the biggest bankruptcy in the country at that time. You find Goldman was waist-deep in it. Penn Central at the time of its bankruptcy in 1970 was the eighth largest corporation in the country. Again, Ellis writes: “the loss it [Penn Central] threatened to impose on Goldman Sachs was not only larger than any prior loss, it was larger than Goldman Sachs.”

And so it is today, that the company once again finds itself in the middle of yet another big crisis that threatens its very existence. I don’t know about you, but I have to wonder about all the brains at Goldman Sachs and all the people who say what a great firm it is. Seems to me, for such a bunch of supposed geniuses, they routinely shoot themselves in the foot, time and time again. You don’t find Berkshire Hathaway fighting for its life every decade.

All of these anecdotes scream at me to avoid the complex and the leveraged, which often means a potential for a mega-loss if you’re wrong. The problem is these kinds of bets infect many companies, as I’ve shown, even when they have nothing to do with the core business. Even otherwise seemingly simple enterprises, like making tortillas or producing chicken, have been hurt.

The advice I have is not novel, but bears repeating since so many seem to forget it. Stay away from anything you don’t understand. (All those folks who lost money with Madoff in his $50 billion Ponzi scheme would’ve saved themselves a lot of money just with this single insight.) And avoid excessive leverage. It’s one thing to lose money. It’s another thing to lose it taking on stupid and pointless risks.

Source: Mindless Risk Taking