Archive for the 'International Investing' Category

Investing in Emerging Market Debt


  • Low correlation to developed markets is good for diversification
  • Have proven resilient to financial crises and are earning investment grade ratings in many cases
  • Sovereign emerging market debt in particular can:
    • respond to negative events by raising taxes and reducing spending
    • have access to lenders such as IMF and the World Bank
    • have large foreign currency reserves as a cushion


  • High volatility
  • Negative skewness of returns
  • Lack of transparency
  • Lack of legal and regulatory structure
  • Sovereign borrowers tend to over-borrow and there can be little recourse for foreign lenders in the event of default

Posted on 24th October 2008
Under: FInancial Planning, Fixed income investments, International Investing, Investing in bonds, Portfolio Management | No Comments »

Barriers to Developing Universally Accepted Accounting Standards

International accounting standards are developed by the IASB, while U.S. GAAP is developed by FASB. In 2002, both standard-setting bodies committed to developing high-quality, compatible accounting standards. In the “Norwalk Agreement,” both standard setters agreed to make best efforts to:

  1. make their existing standards fully compatible as soon as practical
  2. coordinate future development of standards

Since 2004, any significant new standard should be developed cooperatively. Existing differences may take longer to reconcile, as in many cases they represent differences in principles. In addition, industry lobbies and politicians exert pressure on the standard-setters, and these groups may have different motivations in different countries.

Posted on 1st October 2008
Under: Accounting, Financial Statement Analysis, International Investing | No Comments »

Breakeven Spread Analysis

Changes in the spread between domestic and foreign interest rates can diminish the return on a foreign bond investment. Breakeven spread analysis quantifies the amount of spread widening (W) that would eliminate a given yield advantage.

For example, if a foreign bond offers a 300 basis point yield advantage (75 basis points per quarter) adn has a duration of 5:

  • The change in the price of the foreign bond would be 5 X the change in yield or 5W
  • Breakeven = 0.75% X 5W
  • W = 0.13% or 13 basis points

Posted on 24th September 2008
Under: Fixed income investments, International Investing, Investing in bonds, Portfolio Management | No Comments »

Special Issues Related to International Assets

When investing or considering investments in International assets, investors should consider the following special issues:

Currency risk: This affects both return and volatility. Investors must decide whether to hedge this risk.

Correlations with other assets: Although international assets frequently have low correlations with domestic assets, the correlations increase during times of stress. Times of stress are exactly the times in which a low correlation (higher diversification benefit) is most needed.

Emerging markets: Emerging markets tend to be less liquid and less transparent than developed markets. Their investment return distributions tend to be non-normal, which is significant for investors employing mean-variance optimization strategies.

Posted on 20th June 2008
Under: Asset Allocation, FInancial Planning, International Investing, Investment Returns, Portfolio Management | No Comments »

Using Economic Information to Forecast Asset Class Returns


Cash managers can earn higher returns by accepting longer-dated maturities or credit risk. The yield curve reflects the consensus expectation for future interest rates. Managers must distinguish between future events that are reflected in the yield curve adn those that will surprise the market.

Nominal Default Free Bonds

Conventional government bonds of developed countries have little or no default risk. Return can be disaggregated into real return and an inflation premium. The investor must compare his own forecast for inflation with that imbedded in the yield. If the investor believes inflation will be lower than expected, the bonds are a good buy.

Defaultable Debt

Default risk in commercial bonds is reflected in a premium yield relative to Treasuries. This spread tends to widen in recessions as economic stresses increase the likelihood of default. Understanding when a bond is pricing in greater default risk than is necessary can help determine whether securities are attractively priced.

Emerging Market Bonds

The sovereign debt of non-developed countries is often priced in foreign currencies. Since the issuer cannot print the money needed to cover repayment such bonds are subject to default risk, similar to corporate debt of similar ratings. A country risk analysis often involves an understanding of local politics.

Inflation Indexed Bonds

Inflation indexed bonds allow investors to directly observe the consensus inflation forecast by comparison with the yield of conventional bonds. The yield curve will still vary with the real economy and according to supply and demand. However, higher volatility of inflation will increase their hedging value and can result in lower real yields.

Common Stock

The economy affects earnings (cash flows) and interest rates in opposite directions. Trend growth depends on labor growth, investment and productivity while the business cycle affects profitability. In emerging economies, ex-post risk premia have been higher and more volatile than in developed countries.

Real Estate

Returns are affected by growth in consumption, real interest rates, the term structure of interest rates and unexpected inflation. Economic cycles can also affect the cost of building materials and construction labor, but the net effect of lower interest rates is positive for real estate valuations.


Exchange rates reflect the balance between supply and demand. Imports increase currency supply, usually reducing its value. Capital flows for investment purposes, however, may outweigh the effect of trade imbalances. Differences between local interest rates can also affect exchange rates, as the higher yielding currencies attract capital and thus the currency value.

Posted on 19th June 2008
Under: Asset Allocation, Economic Analysis, FInancial Planning, Institutional Investing, International Investing, Investment Returns, Portfolio Management | No Comments »

Dealing With Rising Correlations in Falling Markets

One of the major advantages of international diversification is to reduce overall portfolio risk because the returns on international portfolios have low correlations with the returns on domestic portfolios. However, several studies have shown that correlations across markets are higher when the U.S. market is falling than when it is rising – reducing the value of diversification just when it is needed most.

In the September 2007 Review of Financial Studies Hong, Tu and Zhou sort the CRSP database for monthly returns on 10 style portfolios and the value weighted market index. They find that the correlation asymmetry primarily exists within the four smallest size portfolios.

When considering the asymmetries from an investment decision-making perspective, the authors find that investors with disappointment aversion should reduce their exposure to risky assets, and in particular to the smallest-capitalization stocks.

Posted on 8th June 2008
Under: Active Management, International Investing, Investing in Stocks, Investment Returns, Risk Management, Security Selection | No Comments »

Country Risk Between Emerging and Developed Economies

Emerging economies can be seen as catching up to developed countries economically. They tend to need higher investment rates in physical and human capital. If domestic savings are insufficient to cover this investment, foreign capital may be needed.

Emerging economies have more volatile political and social environments, and may require structural reform to unlock their potential. They tend to be commodity-driven, or dependent upon a narrow industrial niche.

To assess country risk, investors need to ask:

  1. How sound are fiscal and monetary policies?
  2. What are the economic growth prospects?
  3. Is the currency competitive, and are external accounts under control?
  4. Is external debt under control?
  5. Is liquidity plentiful?
  6. Is the political situation supportive of the required policies?

Posted on 19th March 2008
Under: Asset Allocation, Economic Analysis, FInancial Planning, International Investing, Investment Returns, Portfolio Management | No Comments »

Open-End Mutual Funds

An open-ended mutual fund is a pooled investment vehicle. Its shares are publicly offered and can be purchased and redeemed daily at the closing net asset value. Investors must typically announce their intention to redeem shares prior to the end-of-day close, but must wait for the closing price to determine the proceeds they will receive. This eliminates the risk that the fund manager must constantly buy and sell securities solely to meet redemptions. The lag between the decision to buy or sell and the time at which the trade is actually executed can be significant, particularly when the fund invests in foreign securities (in different time zones.)

Posted on 2nd February 2008
Under: International Investing, Investing in Stocks, Investing in bonds | No Comments »

Closed End Country Funds

A closed end fund is an investment vehicle that represents the shares in a certain (usually actively managed) portfolio. The shares of the fund are traded in the stock market as a stock would be – at a price determined by supply and demand for the shares.  The shares cannot usually be redeemed for the underlying portfolio value, but can change hands by buying and selling the representative shares. Investing in a closed-end country fund provides exposure to the local market and international diversification.

Because the shares cannot be redeemed in exchange for the underlying portfolio, the value of the shares will not necessarily represent the net asset value of the portfolio. Instead, it will trade at a premium or discount value compared to the underlying portfolio. By contrast, open-ended funds have limited intra-day trading (investors must wait for the end-of-day net asset value to know how much they must pay to buy or will receive from selling) but will always be valued at the net asset value of the portfolio.

An advantage of the closed-end fund is that the fund manager needn’t focus on redemptions. The ability to redeem shares of an open-ended fund means managers must keep cash on hand to cover redemptions or must sell shares to meet redemptions. Either option can be inefficient at best and detrimental to other shareholders if the securities in the fund are illiquid. This advantage is a key reason why many emerging market funds (where shares are illiquid) are created as closed-end funds.

Because the closed-end fund can trade at a premium or a discount to net asset value, the closed-end fund shares can often be more volatile than the underlying portfolio. Since emerging markets are often volatile already, this can be a disadvantage for investors.

Posted on 2nd January 2008
Under: International Investing, Investing in Stocks, Investing in bonds | No Comments »

American Depositary Receipts (ADRs)

An American Depositary Receipt, or ADR, is a security that represents shares of a foreign company. Shares of the foreign firm are deposited with a bank, which issues the ADRs in the foreign company’s name. An ADR may reflect one share of the foreign firm, multiple shares or even a partial share.

ADRs can be issued with or without the involvement of the foreign company. However, unsponsored ADRs can trade only on the over-the-counter market or pink sheets. When the ADR is sponsored, it can be classified into one of three levels:

  1. A Level I ADR does not comply with SEC regulations and reporting requirements. The shares can only be traded over the counter. They can raise capital only through private placements to qualified investors.
  2. Level II ADRs are registered with the SEC and comply with SEC reporting requirements. They can be listed on exchanges or the NASDAQ market.
  3. Level III ADRs meet the criteria of a Level II ADR and can raise money in the U.S. through public offerings.

ADRs offer the advantage of easy and direct investment in foreign firms, particularly for retail investors. Large investors often find it more efficient to invest directly in the firm by trading on its home market exchange. Not all foreign firms offer ADRs, so investors who limit their foreign investments to ADRs are limiting their options to a narrow subset of the available international securities.

Posted on 2nd December 2007
Under: International Investing, Investing in Stocks, Securities Regulation | No Comments »