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FIN 408 International Investment

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.

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FIN 408 International Investment

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  1. FIN 408International 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.

  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).

  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

  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.

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

  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

  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

  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

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

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

  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.

  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.

  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.

  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.

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