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

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Outline

Emerging Markets
Characteristics  Rationale  Investment Considerations

Special Risks
Country Risk  Trading Costs  Market Pressure  Lack of Financial Information

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Introduction

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.
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Emerging Markets: Characteristics

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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.

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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.

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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.

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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.
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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.
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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

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Review

Emerging Markets
Characteristics  Rationale  Investment Considerations

Special Risks
Country Risk  Trading Costs  Market Pressure  Lack of Financial Information

South-Western / Thomson Learning © 2004

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