Transcript BM410-18 International Analysis and

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
1969
1998
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
1999 $8,351bn
PPP
8,350bn
World GDP
$29,232bn
38,804bn
US share Rank
29%
22%
1
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.
2004
4.0
3.5
3.5
4.3
4.3
6.1
7.8
7.0
4.7
2005
3.2
2.7
2.6
3.2
1.8
5.4
7.1
5.6
3.7
2006
3.2
2.7
2.6
3.3
1.6
5.1
6.6
5.0
3.7
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
International
Return
** *
*
*
*
*
Domestic
*
 Investing internationally shifts the efficient frontier up
and to the right, giving greater opportunities for higher
returns and reduced risk than only domestic investing
Risk
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
rUS = (1 + rFSM) (1 + rFX) - 1
• rUS = return on the foreign investment in US
Dollars
• rFSM = return on the foreign market in local
currency
• rFX = 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
• rUS = (1 + rFM) (1 + rFX) - 1
• rUS = (1.10 £) (1.05 $/£) = (1.155)
•
rUS = 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 + rUS) = (1.10) (.9250) = (1.0175)
• rUS = 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
rp = (1+ rcc)(1+raa)(1+rss)-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
Conservatism
Caution in Assessment
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