Objectives A. Understand the case for global investing B. Understand the key issues in global investing

BM410: Investments International Investing You are not a US analyst With expertise in the US, but a global analyst with expertise in the US

A. The Case for Global Investing What is the difference between global and international investing? Global investing includes the US. International includes all countries except the US. Possible reasons to invest globally: 1. Size of the Markets 2. Economic Representation 3. Economic Growth 4. Opportunity Set 5. Globalization

1. Size Total Investable Capital Markets If you are not investing globally, you are limiting yourself to a much smaller universe of market capitalization US Equities 30.7% 21.7% US $ Bonds 22.3% 19.6% US Real Estate 11.6% 4.3% Japan Equities 1.6% 4.2% Other Equities 11.2% 15.4% All Other Bonds 15.6% 26.1% Total value $2.3 trillion $ 58.2 trn

2. Economic Representation Economic Power The United States is becoming a smaller and smaller percentage of global economic wealth. Not investing globally limits the impact of that global economic growth power in your portfolio Year US GDP World GDP US share Rank 1999 $8,351bn $29,232bn 29% 1 PPP 8,350bn 38,804bn 22% 4

3. Economic Growth Growth Many countries are growing at rates that exceed growth in the United States. Not investing globally limits access to this faster economic growth (world Bank WEP 2005) World GDP (growth) High-income countries OECD countries United States Japan Developing countries East Asia and Pacific Europe and Central Asia Latin America/Carrib South Asia

4. Opportunity Set Places and assets to invest in As you increase the number of assets in your opportunity set, you push the efficient frontier up and to the right Not investing globally limits your chance for higher return and lower risk. As you add more countries to your investment opportunity set, you increase your opportunities for higher returns and lower risk.

Opportunity Set Return Risk * * * * * * * * Domestic International Investing internationally shifts the efficient frontier up and to the right, giving greater opportunities for higher returns and reduced risk than only domestic investing

5. Globalization Globalization As the world gets smaller, companies will continue to take advantage of the comparative advantages of different countries by investing globally Not investing globally limits the reach of the companies you invest in. To remain competitive in a global environment (particularly for specific industries, i.e. steel, transportation, etc.), companies must go global. Investment opportunities will follow as these companies expand

Factors Driving Globalization Democratization of Technology (how we communicate) Result of computerization, telecommunications, digitalization, and the internet Democratization of Finance (how we invest) Result of securitization, knowledge, and movement toward defined benefit plans Democratization of Information (how we see how others live) Result of internet, cable, and technology

Questions Any questions on the case for Global Investing?

B. Issues in Global Investing 1. What are the risks involved in investment in foreign securities? 2. How do you measure benchmark returns on foreign investments? 3. How do you invest internationally, i.e. from Provo? 4. What are the differences in financial reporting?

1. Risks in International Investing Political Risks Expropriation of assets Exchange Rate volatility and restrictions Political instability

Political Risks (continued) What is expropriation of assets? It is the risk that a foreign government will, by fiat, take control and ownership of a foreign operation of a multinational company What is the likelihood of this happening? The probability continues to diminish as more countries join the international community

Political Risks (continued) What is exchange rate volatility and restrictions? Variation in return related to changes in the relative value of the domestic and foreign currency Variations in return related to the possibility that foreign exchange may be restricted and free flow of capital may not be allowed Can you hedge these risks? It is not possible to completely hedge all foreign investments. You may be able to hedge part of those risks, but not all of them

Political Risks (continued) What is political instability? Political instability is the inability to plan due to changes in the ruling political body or government which introduces uncertainty in the operation or planning for a multinational corporation Does it still exist? Yes, even in the US. And on top of these, just the other normal business risks

2. Returns with Foreign Currencies How do you measure US returns in a foreign currency or country? Return to a US investor is a function of two factors Return in the foreign market Return on the foreign exchange

Returns with FX Returns with Foreign Exchange r US = (1 + r FSM ) (1 + r FX ) - 1 r US = return on the foreign investment in US Dollars r FSM = return on the foreign market in local currency r FX = return on the foreign exchange

Example: Dollar Depreciates Initial Investment : $100,000 Initial Exchange Final Exchange $2.00/£ Pound Sterling $2.10/£ Pound Sterling US Dollar depreciated in value, or sterling bought more dollars (Note: if the numerator rises, that means the numerator has depreciated versus the denominator currency, which appreciated) Return in British Security: 10% Return in US Dollars r US = (1 + r FM ) (1 + r FX ) - 1 r US = (1.10 £) (1.05 $/£) = (1.155) r US = 15.5%

Example: Dollar Appreciates Initial Investment : $100,000 Initial Exchange: $2/£ Pound Sterling Final Exchange: $1.85/£ Pound Sterling Here the numerator declined, so the Dollar appreciated, and Sterling bought less dollars so it depreciated Return in British Security: 10% Return in US Dollars (1 + r US ) = (1.10) (.9250) = (1.0175) r US = 1.75%

Global Benchmark Returns What are the Major International Indexes Morgan Stanley EAFE Index MS All Country World S&P 1200 Global Issues in Measuring Performance Weighting Cross-Holdings Other Possibilities Country and Region Funds WEBs

3. International Investment Choices Mutual Funds Actively managed: open-end, closed-end funds Passively managed: International Index funds, WEBS, iShares Depositary Receipts: American/Global ADRs, GDRs, GDSs Direct Stock Purchases in global markets Buying local stocks on the local exchanges in each country (this requires a global and a local custodian financial institution or custodian)

Factors in Assessing Active International Investment Performance Factors Currency Selection Country Selection (asset allocation) Stock Selection Cash / Bond Selection Return on the Portfolio = (1+ the return from currency choice(cc)) * (1 + return from asset allocation (aa)) * (1+ return from stock selection (ss) ) -1 r p = (1+ r cc )(1+r aa )(1+r ss )-1

4. Differences in Financial Reporting: International Accounting Standards Accounting Objectives Investment and credit decisions Assessment of cash flow prospects Evaluation of enterprise resources and auditing Claims to enterprise resources and changes in them Government use and tax planning

International Accounting Standards Factors affecting development of international accounting standards Nature of the enterprise Other external users Enterprise users Accounting profession International Influences Government Local environment

Differences in Accounting Standards Secrecy Less developed Latin American Germanic Japan Less-developed Asian More-developed Latin American Degree of Disclosure African Asian Colonial Nordic Anglo-Saxon (USA) Transparency Optimism Caution in Assessment Conservatism

Sources of International Accounting Information The equivalent of the Securities and Exchange Commission (SEC) from different countries International Accounting books from the library Support documents from large accounting firms which help understand accounting in different countries

Review of Objectives A. Do you understand the case for global investing? B. Do you understand the key issues in global investing