chapter 22 managing an international investment portfolio
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Chapter 22 Managing an International Investment Portfolio. 22.1 Vehicles for Overcoming Capital Flow Barriers 22.2 Share Prices in International Markets 22.3 Asset Allocation Policy and Investment Style 22.4 Cross-Border Financial Statement Analysis - PowerPoint PPT PresentationTRANSCRIPT
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e
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Chapter 22Chapter 22Managing an InternationalManaging an International
Investment PortfolioInvestment Portfolio
22.1 Vehicles for Overcoming Capital Flow Barriers
22.2 Share Prices in International Markets
22.3 Asset Allocation Policy and Investment Style
22.4 Cross-Border Financial Statement Analysis
22.5 The Shifting Sands of Portfolio Analysis
22.6 Portfolio Hedging Strategies
22.7 Summary
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e
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Overcoming capital flow barriersOvercoming capital flow barriers
Domestic-based MNCs
- AdvantageDomestically-based MNCs are familiar and accessible to domestic investors
- DisadvantageMNC share prices move more closely with the domestic stock market than with international markets
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Overcoming capital flow barriersOvercoming capital flow barriers
Domestic-based MNCs Individual foreign securities
- Direct purchase in the foreign market
- Direct purchase in the domestic market
- Foreign shares (American shares in the US)
- Depository receipts (ADRs in the US)
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Overcoming capital flow barriersOvercoming capital flow barriers
Domestic-based MNCs Individual foreign securities Mutual funds of foreign assets
- Mutual funds (open-end or closed-end)
- Many mutual funds are exchange-listed
- Closed-end country funds (CECFs)
- CECFs trading on the NYSE include Brazil, Germany, Italy, India, Korea, Mexico, Malaysia, S. Africa, Spain, Switzerland, Taiwan, Thailand, UK
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Overcoming capital flow barriersOvercoming capital flow barriers
Domestic-based MNCs Individual foreign securities Mutual funds of foreign assets Hedge funds
- Private investment partnerships
- In the U.S., hedge funds have a general manager, fewer than 100 limited partners, and are not regulated by the SEC
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Hedge fund strategiesHedge fund strategies
A wide variety…- Emerging markets- Market-neutral- Opportunistic- Short-selling- Small-cap- Special situations- Value- Arbitrage
e.g., yield-curve arbitrage
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Overcoming capital flow barriersOvercoming capital flow barriers
Domestic-based MNCs Individual foreign securities Mutual funds of foreign assets Hedge funds Other international investment
vehicles- Equity-linked bonds- Index futures, options or swaps
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Share prices in restricted marketsShare prices in restricted markets
Governments allow restricted access to their financial markets through- Closed-end country funds (CECFs)
(mutual funds invested in a single country)
- Unrestricted shares sold internationally(only domestic investors can hold restricted shares)
CECFs and unrestricted shares can trade at substantial premiums to net asset value (NAV)
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e
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International asset pricing with investment restrictions- A classic portfolio maximization
argument
- Assumes rational investors maximizing the mean-variance efficiency of their portfolios
Explanations for share pricesExplanations for share pricesin segmented marketsin segmented markets
Kirt C. Butler, Multinational Finance, South-Western College Publishing, 3e
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Explanations for share prices in Explanations for share prices in segmented marketssegmented markets
International asset pricing with investment restrictions
Investor sentiment- Individual investors trade on their
(possibly irrational) sentiment regarding future returns and risks
- Premiums are large when foreign investor demand is high
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Portfolio investment stylesPortfolio investment styles
Asset allocation policy- A fund’s target weights on various
asset classes
Investment philosophy
- Passive fund management- Benchmarked to an index
- Active fund management- Active asset allocation- Active security selection
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The market timer’s penaltyThe market timer’s penalty
8%
10%
12%
14%
16%
10% 20% 30% 40%
Market timer’s penalty for random switches between Hong Kong and U.S. stocks
US
HK
Buy-and-hold investor
Naive market timer
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Financial accounting measurement Financial accounting measurement
Cross-country financial statement analysis is difficult because of national differences in the measurement of accounting income
- Differences show up in the construction of nearly every financial account
- National accounting differences can result in huge differences in reported income
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There are also cross-border differences in financial disclosure requirements
Alternatives for providing financial information to investors in another country- Do nothing- Prepare convenience translations- Using different accounting principles, such
as IAS standards, in preparing the firm’s financial statements
Financial accounting disclosureFinancial accounting disclosure
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Inputs to portfolio analysis
E[rP] = i Xi E[ri]
P2 = i j Xi Xj ij
The shifting sands of portfolio analysis- Time-varying expected returns & risk premia
- Time-varying volatilities
- Time-varying correlations
Portfolio analysisPortfolio analysis
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Time-varying volatility, 1970-Time-varying volatility, 1970-20022002
-30%
-10%
10%
30%
50%
1
-30%
-10%
10%
30%
50%
1
-30%
-10%
10%
30%
50%
1
-30%
-10%
10%
30%
50%
1
Canada Japan
United Kingdom United States
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60-month rolling correlations60-month rolling correlationswith the U.S. stock marketwith the U.S. stock market
0.0
0.2
0.4
0.6
0.8
1.0
Dec-75 Dec-80 Dec-85 Dec-90 Dec-95 Dec-00
CanadaU.K.Japan
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Returns during the crash of 1987Returns during the crash of 1987
0
20
40
60
80
100
1209/
30/1
987
10/1
/198
7
10/2
/198
7
10/5
/198
7
10/6
/198
7
10/7
/198
7
10/8
/198
7
10/9
/198
7
10/1
2/19
87
10/1
3/19
87
10/1
4/19
87
10/1
5/19
87
10/1
6/19
87
10/1
9/19
87
10/
20/1
987
10/2
1/19
87
10/2
2/19
87
10/2
3/19
87
10/2
6/19
87
10/2
7/19
87
10/
28/1
987
10/2
9/19
87
10/3
0/19
87
JapanU.K.U.S.
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When it rains, it pours…When it rains, it pours…
FactObserved correlations are higher during market downturns than conventional models predict
ConsequenceInternational diversification may fail to yield its promised gains just when they are most needed
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Stock market correlationsStock market correlationsin bear, calm, and bull marketsin bear, calm, and bull markets
USA + World-ex-USA
-0.2
0.0
0.2
0.4
0.6
0.8
-7% -5% -3% -1% 1% 3% 5% 7%
UK + World-ex-UK
-0.2
0.0
0.2
0.4
0.6
0.8
-7% -5% -3% -1% 1% 3% 5% 7%
Japan + World-ex-Japan
-0.2
0.0
0.2
0.4
0.6
0.8
-7% -5% -3% -1% 1% 3% 5% 7%
Australia + World-ex-Australia
-0.2
0.0
0.2
0.4
0.6
0.8
-7% -5% -3% -1% 1% 3% 5% 7%
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Std dev ofannual return
Mean annual returnHedgedforeignstocks
U.S. bonds
Foreign bonds
U.S. stocks
Foreignstocks
Hedgedforeign bonds
Hedged stocksand bonds
Internationally diversifiedstocks and bonds
U.S. stocksand bonds
10%
14%
18%
22%
4% 8% 12% 16% 20%
Adapted from “Asset Allocation with Hedged and Unhedged Foreign Stocks and Bonds” by Philippe Jorion, Journal of Portfolio Management, Summer 1989, p 49-54.
The benefits of currency risk hedgingThe benefits of currency risk hedging