International invest

FIN 408 International Investment:

1 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. non-constant Implications on portfolio diversification Gains from International Diversification.

Factors Affecting Risk and Return :

2 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).

Factors Affecting Risk and Return :

3 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

Factors Affecting Risk and Return:

4 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.

Why Invest in International Funds:

5 Why Invest in International Funds Why Invest in International Funds? Diversification benefits; Fund managers may earn abnormally high returns because of market inefficiency;

Global Market Correlations:

6 Global Market Correlations Global market Correlations Correlation over time - constant vs. non-constant; Correlations between developed markets; Correlations between emerging markets; Implications on portfolio diversification

Global Market Correlations:

7 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

Global Market Correlations:

8 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

Characteristics of ECM :

9 Characteristics of ECM Characteristics of Developing Countries : 1995 Annual per capita GDP less than $8,995 85% of world population 20% of world GDP 11% of world Stock Market Capitalization Relative Size of Emerging Capital Markets (ECM): 1985 $167.7B 1995 $1.9T

Characteristics of ECM:

10 Characteristics of ECM During the same time period, the growth in developed countries : 1985 $4.5 T 1995 $15.9 T 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.

Gains from International Diversification:

11 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.

Gains from International Diversification:

12 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.

Conclusions:

13 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.

Conclusions:

14 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.