Transcript International Investment

FIN 408
International Investment
Factors affecting Risk and Return
Size and Number of International Open-end Funds
Global market Correlations
 Correlation over time - constant vs. nonconstant
 Implications on portfolio diversification
Gains from International Diversification.
1
Factors Affecting Risk and Return
Returns
 World Bank projects that 70% of the growth of
the world’s real GDP during the next 20 years
will come from developing economies in Asia,
Latin America, Eastern Europe and Africa
 January 1987 to may 1993: Stock market
growth in Turkey 637%; Argentina 1,374%;
Mexico 960% (Source: Investor’s Guide to
Emerging Markets).
2
Factors Affecting Risk and Return
There are more people abroad whose incomes are
growing faster (China , India, for example)
 Vast need for infrastructure and technology
investment in the emerging economies
Risks Faced by International Fund Managers
 Currency Risk- pegged to US $, mitigates risk if
invested in single country; hedge currency exposure.
 Political Risk - nationalization
 Inadequate Accounting
 Liquidity problems

3
Factors Affecting Risk and Return
Legal and Regulatory Risk
 Higher costs - market less efficient, higher
transaction cost, fund manager incur additional
travel costs etc.,
Size and Number of International Open-end Funds
 1990-99: Global/International Mutual Funds
assets grew from $46.2b to $501.4b
 Cash flow into international funds in 2000 was
$49.9b.

4
Why Invest in International Funds
Why Invest in International Funds?
 Diversification benefits;
 Fund managers may earn abnormally high
returns because of market inefficiency;
5
Global Market Correlations
Global market Correlations
 Correlation over time - constant vs. nonconstant;
 Correlations between developed markets;
 Correlations between emerging markets;
 Implications on portfolio diversification
6
Global Market Correlations
Correlations / Diversifications with ECM:
1985-95: Correlation = .34
 ECM had higher return and higher risk than
S&P 500
 S&P 500 is not on the efficient frontier
 Minimum Variance Portfolio contained
20% ECM
7
Global Market Correlations
1975-95: Correlation = .27
 ECM had lower return but higher risk than S&P
500
 Minimum Variance Portfolio contained 30% ECM
1990-95: Correlation = .41
 ECM had lower return but higher risk than S&P
500
 Minimum Variance Portfolio contained 10% ECM
8
Characteristics of ECM
Characteristics of Developing Countries:
 1995 Annual per capita GDP less than $8,995
 85% of wold population
 20% of world GDP
 11% of world Stock Market Capitalization
Relative Size of Emerging Capital Markets
(ECM):
 1985 $167.7B
 1995 $1.9T
9
Characteristics of ECM
During the same time period, the growth in
developed countries:
 1985 $4.5 T
 1995 $15.9T
Investors are attracted to ECM because of:
 Return potentials
 Diversification potentials
Performance of ECM:
 ECM are characterized by high risk, high return
and diversification benefits.
10
Gains from International
Diversification
Gains from International Diversification.
 Rationale: international equity market has
higher E(R) than the US market and can
substantially diversify US portfolio.
 Asset pricing models do not argue that risk
factors have geographically different E(R).
 In the US market, value and size explain the
difference in E(R) across equity portfolio
 International value stocks and small stocks
diversify US portfolio more than EAFE.
11
Gains from International
Diversification
Performance of International Open-end
Funds
 Standard Deviation of Monthly Returns;
 Sharpe Ratio for International Funds;
 Jensen’s Alpha for International Funds.
Analyze performance of Well-Diversified
Funds.
12
Conclusions
Conclusions:
 ECMs are an asset class of growing importance
 Historical performance is inconsistent with
common assertion that ECMs always produce
higher average returns.
 ECMs offers diversification opportunities to
global investors.
 Optimal asset allocation changes from period to
period.
13
Conclusions
Future studies should examine:
 Economic reforms and performance of ECMs
 Concentration of wealth in the hands of a small
number of families/holding companies.
 Advantages and disadvantages of these
organizational structure?.
 Corporate financial policies of firms and their
effects on market valuation.
14