CHAPTER FIFTEEN INVESTING INTERNATIONALLY Practical Investment Management Robert A Strong 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  South-Western / Thomson Learning © 2004 15 - Outline  Emerging Markets Characteristics  Rationale  Investment Considerations   Special Risks Country Risk  Trading Costs  Market Pressure  Lack of Financial Information  South-Western / Thomson Learning © 2004 15 - Introduction Insert Figure 15-1 here South-Western / Thomson Learning © 2004 15 - 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 South-Western / Thomson Learning © 2004 15 - 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 South-Western / Thomson Learning © 2004 15 - 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 South-Western / Thomson Learning © 2004 15 - 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 South-Western / Thomson Learning © 2004 15 - 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 South-Western / Thomson Learning © 2004 15 - 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 South-Western / Thomson Learning © 2004 15 - 10 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 South-Western / Thomson Learning © 2004 15 - 11 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 South-Western / Thomson Learning © 2004 15 - 12 Emerging Markets: Characteristics Insert Figure 15-2 (Emerging Market Volatility) here South-Western / Thomson Learning © 2004 15 - 13 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 South-Western / Thomson Learning © 2004 15 - 14 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 South-Western / Thomson Learning © 2004 15 - 15 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 South-Western / Thomson Learning © 2004 15 - 16 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 South-Western / Thomson Learning © 2004 15 - 17 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 South-Western / Thomson Learning © 2004 15 - 18 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  South-Western / Thomson Learning © 2004 15 - 19 Review  Emerging Markets Characteristics  Rationale  Investment Considerations   Special Risks Country Risk  Trading Costs  Market Pressure  Lack of Financial Information  South-Western / Thomson Learning © 2004 15 - 20 ... Individual Securities  Unit Investment Trusts  International Mutual Funds  South-Western / Thomson Learning © 2004 15 - Outline  Emerging Markets Characteristics  Rationale  Investment Considerations... 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 South-Western / Thomson Learning... 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 South-Western / Thomson