Emerging Financial Markets 7. Diversification Can Help Reduce Risk Prof. J.P. Mei

Will Rogers once said: "Take all your savings and buy some good stocks and hold it 'til it goes up, then sell it. If it don't go up, don't buy it". Note: People only complain about diversification when their main bet is winning.

2 International Allocations Company Recommended Foreign Asset Allocation in Overall Portfolio Goldman Sachs 15% to 20% JP Morgan 10% to 15% Lehman About 12% Merrill Lynch 0% to 10% Morgan Stanley 25% to 35% US Trust 8% to 11% Wells Capital Management About 15%

2 International Performace Company Recommended Foreign Asset Allocation in Overall Portfolio SP % China+150% FTSE Europe -9% Japan-32% Nasdaq-39% GEM-32% FTSE World -10%

2 International Diversification u u Benefits of International Investment – –High return potential (market segmentation) – –Lower risk through Diversification u u Short- vs. Long-term Correlation among emerging markets u u Short-term correlation tend to increase during market crisis. u u Long-term Correlation between emerging and developed markets tend to be much less volatile.

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The home country bias u u The sorry state of Japanese retirees u u Chile’s AFPS, Mexico, and Bolivia Pension Scheme u u The "self-interest" of Financial Institutions limits diversification u u Why not just invest in multi-nationals? -They move like pure domestic stocks 6

The Japanese know how to save, but they have a lot to learn about putting their money to work Japanese personal financial assets, $9.6 trillion

US Investors have a more diversified portfolio U.S. personal financial assets*, $21 trillion

The Ten largest US Multinationals Source: Forbes 8

Obstacles to International Diversification u u Lack of Information u u Difficult to trade (high cost) u u FX risk & political risk u u Benefits are not certain u u What is best way of doing it? – –You may not need to go overseas. Use ADRs could capture most benefits. 9

2 Direct Investment u u Buying Emerging Market Stocks Directly – –(1999 new issue $22B, up 44%) u u How do ADRs trade? Just like IBM. – –Pay dividends in $ – –Greater Disclosure & GAAP accounting – –Lower custody cost (save bp) u u Downside: – –Limited menu which may track local market poorly – –Not appropriate for outperforming the local index