2 Learning Objectives Know the benefits of international diversification Understand the risks of international investingTrack developed and emerging marketsRecognize the home biasBe able to utilize the different tools of international investing
3 Global investing benefits Global stock market moves differently from domestic marketsSome international markets grow much faster than domestic marketsGlobal diversification: potential to cushion investor portfolios from downward fluctuations in domestic marketsAdding foreign stocks to portfolio may enhance total returns while reducing overall volatility.
4 Gross Domestic Product and GDP Growth in the Largest Economies Around the World Annualized GDP % GrowthCountry$ billionsUnited States10,9493.53.3Japan4,3014.11.2Germany2,4032.31.5United Kingdom1,7953.22.7France1,7582.41.9Italy1,4682.51.6China1,41710.39.6Canada857Spain8393.12.8Mexico6261.13.0South Korea6058.95.5India6015.75.9Australia5223.43.8Netherlands512Brazil4922.6Russia433.-1.8Switzerland3202.0Belgium3022.1SwedenAustria253Average1,5383.62.9Source: 2005 Word Development Indicators, World Bank
7 Tracking global markets Global market indices available for investorsProblem: local indexes are computed in the local currency, using different computing methodsMorgan Stanley Capital International Inc provides consistent information for global market
8 Morgan Stanley Capital International Apply the same company selection criteria and calculation methodology across all marketsProvide individual country coverage, regional and composite indexes for developed markets, emerging markets and all countries by regionUse full market capitalization weights(Price x number of outstanding shares)
9 Table 17.3 MSCI Global Indices Developed Markets - INTERNATIONAL INDICESEmerging Markets - INTERNATIONAL INDICESEAFEEM (EMERGING MARKETS)EMUEM ASIAEUROEM EASTERN EUROPEEUROPEEM EMEAFAR EASTEM EUROPEG7 INDEXEM EUROPE & MIDDLE EASTNORDIC COUNTRIESEM ex ASIANORTH AMERICAEM FAR EASTPACIFICEM LATIN AMERICAPAN-EUROTHE WORLD INDEXDeveloped Markets - SPECIAL AREASEAFE + CANADAEAFE ex UKEASEA INDEX (EAFE ex JAPAN)EUROPE ex EMUEUROPE ex SWITZERLANDEUROPE ex UKKOKUSAI INDEX (WORLD ex JAPAN)PACIFIC ex JAPANWORLD ex AUSTRALIAWORLD ex EMUWORLD ex EUROPEWORLD ex UKWORLD ex USA
10 Developed Markets Emerging Markets AUSTRALIA AUSTRIA BELGIUM CANADA DENMARKFINLANDFRANCEGERMANYGREECEHONG KONGIRELANDITALYJAPANNETHERLANDSNEW ZEALANDNORWAYPORTUGALSINGAPORESINGAPORE FREESPAINSWEDENSWITZERLANDUNITED KINGDOMUSAEmerging MarketsARGENTINABRAZILCHILECHINACOLOMBIACZECH REPUBLICEGYPTHUNGARYINDIAINDONESIAISRAELJORDANKOREAMALAYSIAMEXICOMOROCCOPAKISTANPERUPHILIPPINESPOLANDRUSSIASOUTH AFRICASRI LANKATAIWANTHAILANDTURKEYVENEZUELASource:
12 Developed and Emerging markets Developed markets: Securities markets in countries with advanced economicsEmerging markets: Securities markets in countries with rapidly evolving economicsProblems with investing in emerging markets: amount of investable assets availablemuch of the equity in emerging markets is not available to international investorsMSCI designates free index and non-free index.
13 Figure 17.5 The U.S., U.K., and Japan Are Dominate Developed Markets; Korea, South Africa, and Taiwan are Major Emerging Markets
14 Countries vs. sectorsDiversifying globally is especially useful when countries have segmented marketsAlternative to country diversification: global sector diversificationMSCI developed the All Country Sector Indices using Global Industry Classification Standard (GICS) systemETF iShares available in global sectors
15 Global Investing Risks Market volatilityInvesting in foreign market involves much higher market volatilityAbove average gain, above average lossOn average, foreign markets have tended to under perform the U.S market while displaying a higher level of return
16 Table 17.4 Annual Returns in Foreign Markets Are More Volatile Than in the US DJ WilshireMSCIYear5000EAFEEmerging Markets198818.0%28.6%34.9%198929.1%10.8%59.2%1990-6.2%-23.3%-13.8%199134.3%12.5%56.0%19929.0%-11.8%9.1%199311.2%32.9%71.3%1994-0.1%8.1%-8.7%199536.4%11.6%-6.9%199621.3%6.4%3.9%199731.3%2.1%-13.4%199823.4%20.3%-27.5%199923.6%25.3%63.7%2000-10.9%-15.2%-31.8%2001-11.0%-22.6%-4.9%2002-20.9%-17.5%-8.0%200331.6%35.3%51.6%200417.6%22.5%200510.9%30.3%Mean11.9%5.7%10.5%S.D.17.4%18.6%33.4%Data sources: and
17 Liquidity riskEmerging markets often permit foreigners to buy only specific classes of shares for certain companies.Scarcity of investment opportunity, thin volume, high premiumHigher market impact cost (costs tied to changing market bid and ask prices)Especially high in emerging markets (brokerage commissions, exchange fees, currency translation costs, custodial fees higher in emerging markets)
18 Political risk Currency risk Loss potential tied to government stemming from coups, assassinations, or civil unrest.Government policy risk: lookout for policy changesExpropriation risk: government confiscation of assetsCurrency riskValue of US dollar and all other currencies fluctuateStrong dollar: increase in the amount of foreign currency per 1 US dollarWeak dollar: decrease in the amount of foreign currency per 1 US dollar
20 Home biasDespite the advantage of international investing, most investors commit very little of their investment portfolio to global equitiesHome biasInvestors believe things they are familiar with are better than things they are not familiar with (familiarity bias)
22 Global investment opportunities Buy multinational companies: exposure to international market, reduce the impact of home bias. (Ex. Coca-Cola, Wal-Mart, Toyota..)Ways to gain global diversificationBuy stocks in companies with corporate headquarters in foreign countriesBuy stocks of multinational corporations that have globally diverse business operation
23 American Depository Receipts (ADRs) Negotiable instruments that represent ownership in the equity securities of a non-US companyIssued by US commercial banksEach ADR shares traded on US exchange is backed by specific number of foreign shares held by a custodian bankADR ratio: number of underlying shares represented by each ADRLevel I ADRs: issuers are not initially seeking to raise capital in USLevel II ADRs: no immediate financing needs, listed on USLevel III ADRs: issuer floats a public offering in US and obtain listing on major US exchange.
24 International BondsDomestic Bonds: Borrowers issuing bonds in their local market.Foreign Bonds: Borrowers from another country issue bonds in your country, denominated in your currencyYankee bondsSamurai bondsBulldog bonds
25 Global mutual fundsInternational stock and bond mutual fund: cost efficient means of investing in global marketsEmerging market’s fund: invest in stocks of companies based in developing countriesGlobal equity fund (or world equity fund): a mutual fund that invests in US and foreign stocksInternational equity fund (foreign fund): invest in the equity of the companies outside the US. Generally prohibited from investing in US equitiesForeign regional fund: an international fund investing in particular geographical region (Europe, Pacific Basin)Single country fund: invest in a sole foreign country (Hong Kong, Mexico, Italy). Closed-end fund, extremely risky.
26 International iShares Barclays Global Investors: leader in Index shares (iShares)International iShares: track market movements around the world.Most popular international iShares based on well-known MSCI indexes.Good options for international exposure in an easy and cost effective way