Investments: Analysis and Behavior

1. Investments: Analysis and Behavior Chapter 17- Global Investing ©2008 McGraw-Hill/Irwin

2. Learning Objectives • Know the benefits of international diversification • Understand the risks of international investing • Track developed and emerging markets • Recognize the home bias • Be able to utilize the different tools of international investing

3. Global investing benefits • Global stock market moves differently from domestic markets • Some international markets grow much faster than domestic markets • Global diversification: potential to cushion investor portfolios from downward fluctuations in domestic markets • Adding foreign stocks to portfolio may enhance total returns while reducing overall volatility.

7. Tracking global markets • Global market indices available for investors • Problem: local indexes are computed in the local currency, using different computing methods • Morgan 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 markets • Provide individual country coverage, regional and composite indexes for developed markets, emerging markets and all countries by region • Use full market capitalization weights (Price x number of outstanding shares)

12. Developed and Emerging markets • Developed markets: Securities markets in countries with advanced economics • Emerging markets: Securities markets in countries with rapidly evolving economics • Problems with investing in emerging markets: amount of investable assets available • much of the equity in emerging markets is not available to international investors • MSCI 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. sectors • Diversifying globally is especially useful when countries have segmented markets • Alternative to country diversification: global sector diversification • MSCI developed the All Country Sector Indices using Global Industry Classification Standard (GICS) system • ETF iShares available in global sectors

15. Global Investing Risks • Market volatility • Investing in foreign market involves much higher market volatility • Above average gain, above average loss • On average, foreign markets have tended to under perform the U.S market while displaying a higher level of return

17. Liquidity risk • Emerging markets often permit foreigners to buy only specific classes of shares for certain companies. • Scarcity of investment opportunity, thin volume, high premium • Higher 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 • Loss potential tied to government stemming from coups, assassinations, or civil unrest. • Government policy risk: lookout for policy changes • Expropriation risk: government confiscation of assets • Currency risk • Value of US dollar and all other currencies fluctuate • Strong dollar: increase in the amount of foreign currency per 1 US dollar Weak dollar: decrease in the amount of foreign currency per 1 US dollar

20. Home bias • Despite the advantage of international investing, most investors commit very little of their investment portfolio to global equities • Home bias • Investors 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 diversification • Buy stocks in companies with corporate headquarters in foreign countries • Buy 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 company • Issued by US commercial banks • Each ADR shares traded on US exchange is backed by specific number of foreign shares held by a custodian bank • ADR ratio: number of underlying shares represented by each ADR • Level I ADRs: issuers are not initially seeking to raise capital in US • Level II ADRs: no immediate financing needs, listed on US • Level III ADRs: issuer floats a public offering in US and obtain listing on major US exchange.

24. International Bonds • Domestic Bonds: Borrowers issuing bonds in their local market. • Foreign Bonds: Borrowers from another country issue bonds in your country, denominated in your currency • Yankee bonds • Samurai bonds • Bulldog bonds

25. Global mutual funds • International stock and bond mutual fund: cost efficient means of investing in global markets • Emerging market’s fund: invest in stocks of companies based in developing countries • Global equity fund (or world equity fund): a mutual fund that invests in US and foreign stocks • International equity fund (foreign fund): invest in the equity of the companies outside the US. Generally prohibited from investing in US equities • Foreign 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