INVESTING INTERNATIONALLY

1. INVESTING INTERNATIONALLY CHAPTER FIFTEEN Practical Investment Management Robert A. Strong

2. Outline • Motivation for International Investing • Diversification • Market Efficiency • Growth • Methods of Investing • American Depository Receipts • Country Funds • Individual Securities • Unit Investment Trusts • International Mutual Funds

3. Outline • Emerging Markets • Characteristics • Rationale • Investment Considerations • Special Risks • Country Risk • Trading Costs • Market Pressure • Lack of Financial Information

4. Introduction Insert Figure 15-1 here.

5. Motivation for International Investing • Diversification: Portfolio risk reduction was the original motivation for international investing. Now however, evidence indicates that this alleged advantage may be overstated.

6. Motivation for International Investing • Market efficiency: Free lunches may exist in underdeveloped markets. • Growth: Many markets are less efficient than those in the United States.

7. Methods of Investing: ADRs • An American depository receipt (ADR) is a marketable receipt showing ownership of a foreign security. • Large commercial banks issue ADRs as a convenience to would-be investors in foreign securities. • A sponsored ADR is issued in coordination with the underlying company.

8. Methods of Investing: GDRs • Global depository receipts (GDRs) are issued in the Euromarket and are backed by the Euromarket depositories rather than by a specific bank. • In practice, the terms ADR, GDR, and DR are interchangeable. They all improve a firm’s access to U.S. investment capital.

9. Methods of Investing • A country fund is a closed-end investment company whose portfolio is comprised almost entirely of securities issued within a particular foreign country. • The fund may contain some short-term domestic securities for holding temporary funds awaiting reinvestment. • Closed-end fund shares typically sell at a discount from their apparent “true” value.

10. Methods of Investing • Individual securities: Individual and institutional investors may also purchase shares directly on a foreign exchange, especially if the exchange is well-developed. • A unit investment trust is a professionally selected, but unmanaged, portfolio of securities designed to meet some stated investment objective.

11. Methods of Investing • International mutual funds are portfolios of securities too. They provide immediate diversification, professional management, and ease of entry and exit from the market. • An important consideration in selecting a mutual fund is the fee charged by the fund manager.

12. Emerging Markets: Characteristics • An emerging market is characterized by a low per capita gross national product. • History: Today’s developed markets were once emerging markets too. • Culture: Significant differences exist among emerging markets, but as a group, they share one primary similarity - change. • The stock market of an emerging country can be particularly volatile, especially by U.S. standards.

13. Emerging Markets: Characteristics Insert Figure 15-2 (Emerging Market Volatility) here.

14. Emerging Markets: Rationale • Adding value: Inefficiencies in developing markets provide opportunities for money to be made. • Reducing risk: While correlations among the developed markets are increasing, emerging markets show little correlation with developed markets or with one another. • Getting on the bandwagon: Current industry practice is another reason for the popularity of international investing.

15. Emerging Markets: Investment Considerations • Accounting information: Reliable accounting information is especially scarce in emerging markets. • Foreign currency risk: Hedging foreign exchange risk is complicated in emerging markets due to the less availability of hedging vehicles.

16. Emerging Markets: Investment Considerations • Fraud: Emerging markets carry a genuine risk of fraud, ranging from accounting misstatements to counterfeit securities or bucket shops. • Liquidity risk: Residents of a developing country typically have little money of their own to invest.

17. Special Risks: Country Risk • Country risk refers to a country’s ability and willingness to meet its foreign exchange obligations. • The two components to country risk are political risk and economic risk. • Political risk is a measure of a country’s willingness to honor its foreign obligations. • Economic risk is a measure of the country’s ability to pay. It is largely a function of the income statement rather than of the balance sheet.

18. Special Risks • Foreign market investing is likely to involve trading costs at least one percent higher than investing domestically. • Market pressure can be an important trading cost in international markets, especially with small-capitalization stocks. • Lack of financial information: Some particular problems with financial information sources are inherent in emerging markets. Often, accounting standards differ too.

19. Review • Motivation for International Investing • Diversification • Market Efficiency • Growth • Methods of Investing • American Depository Receipts • Country Funds • Individual Securities • Unit Investment Trusts • International Mutual Funds

20. Review • Emerging Markets • Characteristics • Rationale • Investment Considerations • Special Risks • Country Risk • Trading Costs • Market Pressure • Lack of Financial Information