Investments: Analysis
and Behavior
Chapter 17- Global Investing
©2008 McGraw-Hill/Irwin
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
17-2
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.
17-3
Gross Domestic Product and GDP Growth in the Largest Economies Around the World
Country
United States
Japan
Germany
United Kingdom
France
Italy
China
Canada
Spain
Mexico
South Korea
India
Australia
Netherlands
Brazil
Russia
Switzerland
Belgium
Sweden
Austria
Average
2003 GDP
$ billions
10,949
4,301
2,403
1,795
1,758
1,468
1,417
857
839
626
605
601
522
512
492
433
320
302
302
253
1,538
Source: 2005 Word Development Indicators, World Bank
Annualized GDP % Growth
1980-90
1990-2003
3.5
3.3
4.1
1.2
2.3
1.5
3.2
2.7
2.4
1.9
2.5
1.6
10.3
9.6
3.2
3.3
3.1
2.8
1.1
3.0
8.9
5.5
5.7
5.9
3.4
3.8
2.4
2.7
2.7
2.6
.
-1.8
2.0
1.2
2.1
2.1
2.5
2.3
2.3
2.1
3.6
2.9
17-4
Figure 17.1 Country Stock Market Returns
900%
Australia
800%
S&P 500
700%
Japan
600%
500%
400%
300%
200%
100%
0%
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
-100%
1984
Cumulative Return
United Kingdom
17-5
Average Annual Return (%)
Figure 17.2 Efficient Portfolios Contain Domestic and
Foreign Stocks (1985-05)
Higher
Portfolio A
+12.6% Return
16.8% Risk
Portfolio B
+12.5% Return
16.5% Risk
Portfolio C
+12.2% Return
18.3% Risk
Lower
Risk (%) (Standard Deviation)
Higher
Portfolio A = 100% Domestic Stocks
Portfolio B = 95% Domestic, 5% Foreign
Portfolio C = 50% Domestic, 50% Foreign
Data source: http://www.vanguard.com.
17-6
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
17-7
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)
17-8
Table 17.3 MSCI Global Indices
Developed Markets INTERNATIONAL INDICES
Emerging Markets INTERNATIONAL INDICES
EAFE
EM (EMERGING MARKETS)
EMU
EM ASIA
EURO
EM EASTERN EUROPE
EUROPE
EM EMEA
FAR EAST
EM EUROPE
G7 INDEX
EM EUROPE & MIDDLE EAST
NORDIC COUNTRIES
EM ex ASIA
NORTH AMERICA
EM FAR EAST
PACIFIC
EM LATIN AMERICA
PAN-EURO
THE WORLD INDEX
Developed Markets - SPECIAL
AREAS
EAFE + CANADA
EAFE ex UK
EASEA INDEX (EAFE ex JAPAN)
EUROPE ex EMU
EUROPE ex SWITZERLAND
EUROPE ex UK
KOKUSAI INDEX (WORLD ex JAPAN)
PACIFIC ex JAPAN
WORLD ex AUSTRALIA
WORLD ex EMU
WORLD ex EUROPE
WORLD ex UK
WORLD ex USA
17-9
Developed Markets
Emerging Markets
AUSTRALIA
ARGENTINA
AUSTRIA
BRAZIL
SOUTH AFRICA
BELGIUM
CHILE
SRI LANKA
CANADA
CHINA
TAIWAN
DENMARK
COLOMBIA
THAILAND
FINLAND
CZECH REPUBLIC
TURKEY
FRANCE
EGYPT
VENEZUELA
GERMANY
HUNGARY
GREECE
INDIA
HONG KONG
INDONESIA
IRELAND
ISRAEL
ITALY
JORDAN
JAPAN
KOREA
NETHERLANDS
MALAYSIA
NEW ZEALAND
MEXICO
NORWAY
MOROCCO
PORTUGAL
PAKISTAN
SINGAPORE
PERU
SINGAPORE FREE
PHILIPPINES
SPAIN
POLAND
SWEDEN
RUSSIA
Source: www.msci.com
SWITZERLAND
UNITED KINGDOM
USA
17-10
12/30/2005
6/30/2005
12/30/2004
6/30/2004
12/30/2003
6/30/2003
12/30/2002
6/30/2002
12/30/2001
6/30/2001
12/30/2000
MSCI World Index
World ex USA
6/30/2000
$350
12/30/1999
USA Index
6/30/1999
$400
12/30/1998
6/30/1998
12/30/1997
6/30/1997
12/30/1996
6/30/1996
12/30/1995
6/30/1995
12/30/1994
Value of $100 Invested
Figure 17.3 Global Equity Markets Soared During the Late-1990s and Then Collapsed
$300
$250
$200
$150
$100
$50
$0
Data source: http://www.msci.com
17-11
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.
17-12
Figure 17.5 The U.S., U.K., and Japan Are Dominate Developed Markets;
Korea, South Africa, and Taiwan are Major Emerging Markets
A. Developed Markets
UNIT ED KINGDOM
8.3%
GERMANY
4.0%
JAPAN
12.1%
FRANCE
3.6%
CANADA
2.3%
SWIT ZERLAND
2.1%
B. Emerging Markets
OT HER DEVELOPED
MARKET S
13.9%
USA
47.2%
EMERGING MARKET S
6.4%
OT HER EMERGING
MARKET S
15.7%
T AIWAN
13.4%
BRAZIL
7.7%
CHINA
7.0%
MALAYSIA
6.0%
SOUT H AFRICA
13.6%
RUSSIA
4.9%
MEXICO
7.9%
INDIA
4.9%
KOREA
18.9%
17-13
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
17-14
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
17-15
Table 17.4 Annual Returns in Foreign Markets Are More Volatile Than in the US
Mean
DJ Wilshire
MSCI
MSCI
Year
5000
EAFE
Emerging Markets
1988
18.0%
28.6%
34.9%
1989
29.1%
10.8%
59.2%
1990
-6.2%
-23.3%
-13.8%
1991
34.3%
12.5%
56.0%
1992
9.0%
-11.8%
9.1%
1993
11.2%
32.9%
71.3%
1994
-0.1%
8.1%
-8.7%
1995
36.4%
11.6%
-6.9%
1996
21.3%
6.4%
3.9%
1997
31.3%
2.1%
-13.4%
1998
23.4%
20.3%
-27.5%
1999
23.6%
25.3%
63.7%
2000
-10.9%
-15.2%
-31.8%
2001
-11.0%
-22.6%
-4.9%
2002
-20.9%
-17.5%
-8.0%
2003
31.6%
35.3%
51.6%
2004
12.5%
17.6%
22.5%
2005
6.4%
10.9%
30.3%
11.9%
5.7%
10.5%
S.D.
17.4%
18.6%
Data sources: http://www.vanguard.com and http://www.msci.com.
33.4%
17-16

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)
17-17

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
17-18
1/14/2006
11/14/2005
9/14/2005
7/14/2005
5/14/2005
3/14/2005
1/14/2005
$0.80
11/14/2004
9/14/2004
7/14/2004
5/14/2004
3/14/2004
1/14/2004
11/14/2003
9/14/2003
7/14/2003
5/14/2003
3/14/2003
1/14/2003
11/14/2002
9/14/2002
7/14/2002
5/14/2002
3/14/2002
$1.80
1/14/2002
11/14/2001
9/14/2001
7/14/2001
5/14/2001
Number of Dollars to Buy One Euro or Pound
Figure 17.6 The Dollar has Weakened Over the Past Five Years
$2.20
$2.00
Value of One U.K. Pound
$1.60
$1.40
$1.20
$1.00
Value of One Euro
$0.60
Source: Federal Reserve Economic Data (FRED)
17-19
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)
17-20
Figure 17.7 Investors Mostly Own Domestic Stocks
95.7%
92.2%
100%
92.0%
93.4%
89.4%
90%
79.0%
80%
70%
60%
50%
47.2%
40%
30%
20%
10%
12.1%
0%
8.3%
United States
4.0%
3.6%
Japan
Country's Market Weight in Global Equity Market
2.3%
United
Kingdom
Germany
France
Canada
Domestic Investor Ownership in Own Country
17-21
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
17-22

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.
17-23
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
17-24

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.
17-25

International iShares
 Barclays
Global Investors: leader in Index shares
(iShares)
 International iShares: track market movements
around the world.
 Most popular international iShares based on wellknown MSCI indexes.
 Good options for international exposure in an easy
and cost effective way
17-26