Download Chapter 18 - Performance Evaluation

Fin2802: Investments
Spring, 2008
Dragon Tang
Lecture 23
International Investing
April 10/11, 2008
Readings: Chapter 25
Practice Problem Sets: 1,4,7
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Case Studies Recap
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Warren Buffett: Investing in the value you know
Jack Bogle: Passive investing with low costs
Bill Miller: Contrarian, bargain hunter
Intel valuation: Fragile market/analyst/investor
GSAM Active Alpha
Fidelity Magellan: Peter Lynch One Up on Wall Street
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International Investing
Objectives:
1. Risks in international investing
2. Benefits of international investing
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Background
• Global market
– US market is approx. 45% of all markets
– Emerging market development
– Market capitalization and GDP
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Figure 25.1 Per Capita GDP and Market Capitalization
as Percentage of GDP (log scale)
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Issues
• What are the risks involved in investment in foreign
securities?
• How do you measure benchmark returns on foreign
investments?
• Are there benefits to diversification in foreign securities?
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Risks in International Investing:
Foreign Exchange
Exchange Rate Risk
• Variation in return related to changes in the
relative value of the domestic and foreign currency
• Total Return = Investment return plus return on
foreign exchange
• Not possible to completely hedge a foreign
investment
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Returns with FX
• Return in US is a function of two factors
1. Return in the foreign market
2. Return on the foreign exchange
(1 + rUS) = (1 + rFM) (1 + rFX)
rUS = return on the foreign investment in US Dollars
rFM = return on the foreign market in local currency
rFX = return on the foreign exchange
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Return Example:
Dollar Depreciates Relative to the Pound
Initial Investment : $100,000
Initial Exchange: $2.00/ Pound Sterling
Final Exchange:$2.10/ Pound Sterling
Return in British Security: 10%
Return in US Dollars
(1 + rUS) = (1.10) (1.05) = (1.155)
rUS = 15.5%
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Return Example:
Dollar Appreciates Relative to the Pound
Initial Investment : $100,000
Initial Exchange: $2/ Pound Sterling
Final Exchange: $1.85/ Pound Sterling
Return in British Security: 10%
Return in US Dollars
(1 + rUS) = (1.10) (.9250) = (1.0175)
rUS = 1.75%
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Figure 25.2 Stock Market Returns
in U.S. Dollars and Local Currencies for 2005
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Table 25.3 Rates of Change in the U.S. Dollar
against Major World Currencies, 2001 – 2005 (monthly data)
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Other Risks in International Investing
Country - Specific
• Composition
– Political
– Financial
– Economic
• Composite Ratings
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Table 25.4 Composite Risk Ratings
for October 2004 and November 2003
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Table 25.5 Variables Used in PRS’s Political Risk Score
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Table 25.6 Current Risk Ratings and Composite Risk Forecasts
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Table 25.7 Composite and Political Risk Forecasts
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Table 25.8 Political Risk Points by Component, October 2004
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Int’l Investment Choices
• Direct Stock Purchases
• Mutual Funds
– Open End
– Closed End
– WEBS
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Questions on Assessing Performance in US
Dollars in Foreign Markets
• Are emerging markets riskier?
• Is exchange rate risk important in
international portfolios?
• Are there diversification benefits to
international investing?
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Table 25.9 Risk and Return across the Globe, 2001 – 2005 (Developed Countries)
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Table 25.9 Risk and Return across the Globe, 2001 – 2005 (Emerging Markets)
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Figure 25.3 Annualized Standard Deviation of Investments across the Globe
($ returns 2001 – 2005)
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Figure 25.4 Beta on U.S. Stocks across the Globe, 2001 – 2005
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Figure 25.3 Annualized Average $ Return of Investments
across the Globe 2001 – 2005
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Figure 25.6 Standard Deviation of Investments across the Globe
in U.S. Dollars versus Local Currency, 2001 – 2005
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Diversification Benefits
Evidence shows international diversification is
beneficial
• Possible to expand the efficient frontier above
domestic only frontier
• Possible to reduce the systematic risk level below
the domestic only level
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Table 25.11 Correlation of U.S. Equity Returns with Country Equity Returns
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Figure 25.7 International Diversification
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Figure 25.8 Ex Post Efficient Frontier of Country Portfolios, 2001 – 2005
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Figure 25.9 Efficient Frontier of Country Portfolios
(world expected excess return = .6% per month)
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Figure 25.10 Regional Indexes around the Crash,
October 14 – October 26, 1987
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Figure 25.11 Efficient Diversification by Various Methods
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Figure 25.12 Diversification by Market Capitalization:
National Markets versus Regional Funds
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Figure 25.13 Diversification Benefits over Time
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Table 25.12 Weighting Schemes for EAFE Countries
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Performance Attribution with International
Extension to consider additional factors
• Currency selection
• Country selection
• Stock selection
• Cash and bond selection
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Table 25.13 Example of Performance Attribution: International
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Summary
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World financial markets
Risks in international investing
International diversification
Next class: Behavioral Finance
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