Chapter 24 Managing an International Investment Portfolio

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Chapter 24Managing an International Investment
Portfolio

• 24.1 Vehicles for Overcoming Capital Flow
  Barriers
• 24.2 Asset Allocation Policy and Managerial Style
• 24.3 Cross-Border Financial Statement Analysis
• 24.4 The Shifting Sands of Portfolio Analysis
• 24.5 Portfolio Hedging Strategies
• 24.6 Summary

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Vehicles for overcoming capital flow barriers

• Domestic-based MNCs
• Individual foreign securities
• Direct purchase in the foreign market
• Direct purchase in the domestic market
• Foreign shares (e.g. American shares in the U.S.)
• Depository receipts (e.g. ADRs in the U.S.)
• Mutual funds specializing in foreign securities
• Closed-end and open-end mutual funds
• Closed-end country funds
• Hedge funds - private investment partnerships
• Other international investment vehicles
• Equity-linked Eurobonds
• Stock index futures, options, and swaps

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Closed-end country funds

• Closed-end country funds invest in a single
  countrys stocks
• CECFs trading on the NYSE include
• Brazil Germany Italy India
• Korea Mexico Malaysia South Africa
• Spain Switzerland Taiwan Thailand
• United Kingdom
• The CECFs of restricted markets can trade at
  substantial premiums or discounts to net asset
  value.
• classic portfolio maximization
• investor sentiment

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Hedge funds

• Hedge funds are private investment partnerships
• a general manager and fewer than 100 limited
  partners
• unregulated (as long as each partner passes SEC
  accreditation)
• Hedge fund strategies include
• arbitrage
• emerging markets
• market-neutral
• opportunistic
• short-selling
• small-cap
• special situations
• value
• yield-curve arbitrage

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Portfolio management styles

• Asset allocation policy
• target weights on asset classes
• Investment philosophy
• Passive fund management
• often benchmarked to an index
• Active fund management
• active asset allocation
• active security selection

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Cross-border financial statement analysis

• Accounting systems influence statement analysis
• Legalistic accounting systems
• Emphasis is on the legal entity
• Used in code law countries such as France and
  Germany
• Accounting rules consist of thou shalts
• Nonlegalistic accounting systems
• Emphasis is on the economic entity
• Used in common law countries such as the United
  Kingdom and the United States
• Accounting rules consist of a list of thou shalt
  nots

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Cross-border financial statement analysis

• Differences in financial accounting measure are
  particularly prominent in accounting for
• Goodwill
• Discretionary reserves
• Pension liabilities
• Inflation accounting

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Cross-border financial statement
analysisInternational financial disclosure

• Responses to the need for financial information
• Do nothing
• Prepare convenience translations
• Restate selected items
• Prepare financial statements using another
  countrys accounting principles
• There are notable international differences in
  financial disclosure requirements

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Portfolio analysis

• Inputs to portfolio analysis
• ERP Si Xi ERi
• Var(RP) Si Xi2 si2 Si Sj Xi Xj sij
• i¹j
• The shifting sands of portfolio analysis
• Time-varying expected returns
• Time-varying risk premiums
• Time-varying volatilities
• Time-varying correlations

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60-month rolling correlationswith the U.S. stock
market
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National markets during the international stock
market crash of October 1987
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Are Cross-Country Correlations Constant?

• Longin Solnik estimated national stock market
  correlations during periods of high and low
  market volatility assuming constant correlations
  ri,us between index i and the U.S. market.
• Francois Longin and Bruno Solnik, Is the
  Correlation in International
• Equity Returns Constant? Journal of
  International Money and Finance,
• No. 1, 1995.

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Are Cross-Country Correlations Constant?

• National stock market returns were modeled with
  autoregressive variances
• si,t2 ai bi si,t-12 ci si,t-12
• where
• si,t-12 conditional variance from previous
  period
• si,t-12 square of return during previous
  period
• ai, bi, and ci are constants for stock market
  index i
• Conditional covariance is si,ust
  ri,ussi,tsus,t
• given conditional variances si,t2 and sus,t2

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Are Cross-Country Correlations Constant?

• Correlation with U.S. market
• Calm Volatile Unconditional
• Country periods periods correlation
• Canada 0.729 0.753 0.723
• France 0.331 0.525 0.407
• Germany 0.327 0.461 0.353
• Japan 0.265 0.366 0.297
• Switzerland 0.458 0.650 0.508
• U.K. 0.468 0.525 0.469

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The benefits of currency risk hedging