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How can I get foreign equity exposure without investing in mutual funds?

Once you've decided to broaden your investing beyond Canada, you have to decide between active management and passive. Active managers pick stocks which they think will give the best return. Passive management, in contrast, is investing in a group of stocks designed to represent a broad stock index. The intent of indexed investing is not to beat that underlying index, just to match it.

If you invest directly in foreign stocks, you have to concern yourself with various accounting and settlement standards. Investments that will give you less complex and typically less costly access to global equity markets include index participation units like World Equity Benchmark Shares (WEBS) and Standard and Poor's Depository Receipts (SPDRS). These are both passively managed products that let you track the returns of foreign stock market indexes. Like stocks, index participation units trade on stock exchanges. You can get them through your broker, paying a commission when you buy or sell. WEBS and SPDRS are traded on the American Stock Exchange. You can find them listed in The Globe and Mail and the Financial Post. WEBS represent a portfolio of company shares tied to a particular Morgan Stanley Capital International (MSCI) market index. They are available on 17 different countries. WEBS trade under the name EWx: the x being replaced by the appropriate country designation. The German WEBS is EWG; Japan is EWJ. SPDRS, based on the U.S. S&P 500 Composite index, trade under the symbol SPY. There some possible complications you should remember about SPDRS and WEBS. First, WEBS and SPDRS will lose money when their underlying benchmark indexes perform poorly. Second, SPDRS and WEBS are tied to a specific country. So they don't offer the diversification of a broad international mutual fund. Third, because the units of each SPDRS and WEBS series trade in U.S. dollars, Canadian investors have foreign currency risk or exposure through the underlying securities to the U.S. dollar. In fact, in the case of WEBS, there is an extra currency risk for Canadians: That's because there is the risk between the foreign market currency and that of the U.S. currency, and, in turn, the risk between the U.S. and Canadian currencies. Currency risk is what you take on when you invest in foreign markets: you might win or lose on the currency exchange. That could wipe out gains you made in the foreign market if the currency goes against you. Dividends paid by SPDRS and WEBS are not eligible for the Canadian dividend tax credit. If you sell these investments for more than you paid, you have to pay tax on the capital gain, the same as on Canadian investments. Any dividends paid by SPDRS and WEBS are subject to a withholding tax of 15 per cent collected by the U.S. government. You can claim a foreign tax credit on your income tax return to take that into account. WEBS and SPDRS can be held in your RRSP, subject to the 30 per cent foreign content restrictions. By adding international investments to your portfolio, you can increase diversification, reducing your risk. The volatility of your overall portfolio will probably decrease if part of it is invested internationally. And your returns may be higher, too. But those risk-reducing benefits apply mainly to international equities that are held for the long term. In the short run, individual markets, especially emerging ones, are more volatile than those in Canada. A combination of currency devaluations and market downturns in mid 1998, for example, saw WEBS tracking markets in Malaysia and Singapore fall about 20 per cent in early July. Index participation units may or may not be suitable for your needs. Consider getting professional investment advice before making investment decisions.