3global Diversification and Asset Class[1]
Transcript of 3global Diversification and Asset Class[1]
-
8/8/2019 3global Diversification and Asset Class[1]
1/57
Selecting Investments in aGlobal Market
Questions to be answered:
Why sh ould investors h ave a globalperspective regarding t h eir investments?
-
8/8/2019 3global Diversification and Asset Class[1]
2/57
Selecting Investments in aGlobal MarketQuestions to be answered:
Wh at are t h e differences in t h e rates of return on U.S. and foreign securitiesmarkets?
-
8/8/2019 3global Diversification and Asset Class[1]
3/57
Investments in a GlobalMarketQuestions to be answered:
H ow can c h anges in currenc y exc h angerates affect t h e returns
-
8/8/2019 3global Diversification and Asset Class[1]
4/57
Investments in a GlobalMarketQuestions to be answered:
Is t h ere an additional advantage of diversif ying in international marketsbe yond t h e benefits of domesticdiversification?
-
8/8/2019 3global Diversification and Asset Class[1]
5/57
Investments in a GlobalMarket
Questions to be answered:
Wh at alternative securities are available?Wh at are t h eir cas h flow and risk properties?
-
8/8/2019 3global Diversification and Asset Class[1]
6/57
Investments in a GlobalMarketQuestions to be answered:
Wh at is t h e h istorical return and risk ch aracteristics of t h e major investmentinstruments?
-
8/8/2019 3global Diversification and Asset Class[1]
7/57
Investments in a GlobalMarketQuestions to be answered:
Wh at is t h e relations h ip among returnsfor foreign and domestic investmentinstruments? Wh at is t h e implication of th ese relations h ips for portfoliodiversification?
-
8/8/2019 3global Diversification and Asset Class[1]
8/57
R easons for t h e expansion of investment opportunities
1. Growth and development of foreignfinancial markets
2. Advances in telecommunicationstechnology
3. Mergers of firms and security exchanges
-
8/8/2019 3global Diversification and Asset Class[1]
9/57
T h e Case for Constructing
Global Investment Portfolios1. Ignoring foreign markets can substantially
reduce the investment choices for investors
2. The rates of return on non-U.S. securitiesoften have substantially exceeded those for
U.S.-only securities3. The low correlation between U.S. stock markets and many foreign markets canhelp to substantially reduce portfolio risk
-
8/8/2019 3global Diversification and Asset Class[1]
10/57
-
8/8/2019 3global Diversification and Asset Class[1]
11/57
T h e Case for GlobalInvestments
D iversification with foreign securities canhelp reduce portfolio risk because foreignmarkets have low correlation with U.S. capitalmarkets
-
8/8/2019 3global Diversification and Asset Class[1]
12/57
Global Bond Portfolio R isk 1. Macroeconomic differences cause the
correlation of bond returns between thecountries to differ
2. The correlation of returns between a single pair of countries changes over time
because the factors influencing thecorrelation change over time
-
8/8/2019 3global Diversification and Asset Class[1]
13/57
R isk of Combined Countr y Investments
D iversified portfolios reduce variability of
returns over time
for bonds and stocks
-
8/8/2019 3global Diversification and Asset Class[1]
14/57
Summary on Global InvestingR elatively high rates of return
combined with low correlation
coefficients indicate that adding
foreign stocks and bonds to a
portfolio will reduce risk and may
increase its average return
-
8/8/2019 3global Diversification and Asset Class[1]
15/57
Global Investment C h oicesFixed-income investments bonds and preferred stocks
Equity investmentsSpecial equity instruments warrants and options
Futures contractsInvestment companies
R eal assets
-
8/8/2019 3global Diversification and Asset Class[1]
16/57
F ixed- Income InvestmentsContractual payment scheduleR ecourse varies by instrument
Bonds investors are lenders expect interest payment and return of
principalPreferred stocks dividends require board of directors
approval
-
8/8/2019 3global Diversification and Asset Class[1]
17/57
Savings AccountsFixed earningsConvenientLiquidLow risk Low ratesCertificates of D eposit (C D s)
- instruments that require minimum depositsfor specified terms, and pay higher rates of interest than savings accounts. Penaltyimposed for early withdrawal
-
8/8/2019 3global Diversification and Asset Class[1]
18/57
Capital Market InstrumentsFixed income obligations that trade in
secondary market
U.S. Treasury securities
U.S. Government agency securities
Municipal bonds
Corporate bonds
-
8/8/2019 3global Diversification and Asset Class[1]
19/57
T reasur y SecuritiesBills, notes, or bonds - depending onmaturity
Bills mature in less than 1 year Notes mature in 1 - 10 years Bonds mature in over 10 yearsHighly liquidBacked by the full faith and credit of theGovernment
-
8/8/2019 3global Diversification and Asset Class[1]
20/57
Corporate BondsIssued by a corporation
Fixed income
Credit quality measured by ratingsMaturity
Features
Indenture Call provision
Sinking fund
-
8/8/2019 3global Diversification and Asset Class[1]
21/57
Corporate BondsSenior secured bonds most senior bonds in capital structure and have
the lowest risk of default
Mortgage bonds secured by liens on specific assets
Collateral trust bonds secured by financial assets
Equipment trust certificates secured by transportation equipment
-
8/8/2019 3global Diversification and Asset Class[1]
22/57
-
8/8/2019 3global Diversification and Asset Class[1]
23/57
Corporate BondsIncome bonds Interest payment contingent upon earning
sufficient incomeConvertible bonds Offer the upside potential of common
stock and the downside protection of a bond
Usually have lower interest rates
-
8/8/2019 3global Diversification and Asset Class[1]
24/57
Corporate BondsWarrants Allows bondholder to purchase the firms
common stock at a fixed price for a given time period
Interest rates usually lower on bonds withwarrants attached
Zero coupon bond Offered at a deep discount from the face value No interest during the life of the bond, only the
principal payment at maturity
-
8/8/2019 3global Diversification and Asset Class[1]
25/57
Preferred Stock Hybrid securityFixed dividends
D ividend obligations are not legally binding, but must be voted on by the boardof directors to be paid
Most preferred stock is cumulativeCredit implications of missing dividendsCorporations may exclude 80% of dividendincome from taxable income
-
8/8/2019 3global Diversification and Asset Class[1]
26/57
International Bond InvestingBond identification characteristics Country of origin
Location of primary trading market Home country of the major buyers Currency of the security denomination
Eurobond An international bond denominated in a
currency not native to the country where it isissued
-
8/8/2019 3global Diversification and Asset Class[1]
27/57
International Bond InvestingYankee bonds Sold in the United States and denominated is
U.S. dollars, but issued by foreign corporationsor governments
Eliminates exchange risk to U.S. investors
International domestic bonds Sold by issuer within its own country in thatcountrys currency
-
8/8/2019 3global Diversification and Asset Class[1]
28/57
Eq uit y InvestmentsR eturns are not contractual and
may be better or worse than ona bond
-
8/8/2019 3global Diversification and Asset Class[1]
29/57
Eq uit y InvestmentsCommon Stock
R epresents ownership of a firm
Investors return tied to performance of the company and may result in loss or gain
-
8/8/2019 3global Diversification and Asset Class[1]
30/57
Classification of Common Stock Categorized B y General Business
LineIndustrial: manufacturers of automobiles,machinery, chemicals, beveragesUtilities: electrical power companies, gassuppliers, water industryTransportation: airlines, truck lines,
railroadsFinancial: banks, savings and loans, creditunions
-
8/8/2019 3global Diversification and Asset Class[1]
31/57
Ac q uiring F oreign Eq uities1. Purchase of American D epository R eceipts
(ADR s)
2. Purchase of American shares3. D irect purchase of foreign shares listed on a
U.S. or foreign stock exchange
4. Purchase of international mutual funds
-
8/8/2019 3global Diversification and Asset Class[1]
32/57
Purc h ase or Sale of Global MutualF unds or ETF s
Global funds - invest in both U.S. andforeign stocksInternational funds - invest mostly outside
the U.S.Funds can specialize D iversification across many countries Concentrate in a segment of the world
Concentrate in a specific country Concentrate in types of marketsExchange-traded funds or ETFs are a recentinnovation in the world of index products
-
8/8/2019 3global Diversification and Asset Class[1]
33/57
Special Eq uit y InstrumentsEquity-derivative securities have a claim oncommon stock of a firm
Options are rights to buy or sell at a stated price for a period of timeWarrants are options to buy from thecompanyPuts are options to sell to an investor Calls are options to buy from a stockholder
-
8/8/2019 3global Diversification and Asset Class[1]
34/57
F utures ContractsExchange of a particular asset at a specifieddelivery date for a stated price paid at the
time of deliveryD eposit (10% margin) is made by buyer atcontract to protect the seller
Commodities trading is largely in futurescontractsCurrent price depends on expectations
-
8/8/2019 3global Diversification and Asset Class[1]
35/57
Investment CompaniesMoney market funds Acquire high-quality, short-term investments
Yields are higher than normal bank C D s Typical minimum investment is $1,000
No sales commission charges
Withdrawal is by check with no penalty Investments usually are not insured
-
8/8/2019 3global Diversification and Asset Class[1]
36/57
Investment CompaniesBond funds Invest in long-term government,
corporate, or municipal bonds
Bond funds vary in bond quality selectedfor investment
Expected returns vary with risk of bonds
-
8/8/2019 3global Diversification and Asset Class[1]
37/57
Investment CompaniesCommon stock funds Many different funds with varying stated
investment objectives
Aggressive growth, income, precious metals,international stocks
Offer diversification to smaller investors Sector funds concentrate in an industry
International funds invest outside the UnitedStates Global funds invest in the U.S. and other
countries
-
8/8/2019 3global Diversification and Asset Class[1]
38/57
Investment CompaniesBalanced funds Invest in a combination of stocks and
bonds depending on their statedobjectives
-
8/8/2019 3global Diversification and Asset Class[1]
39/57
Investment CompaniesIndex Funds These are mutual funds created to equal
the performance of a market index likethe S&P 500
-
8/8/2019 3global Diversification and Asset Class[1]
40/57
Investment CompaniesExchange-Traded Funds (ETFs) These are depository receipts for a portfolio of
securities deposited at a financial institution ina unit trust that issues a certificate of ownershipfor the portfolio of stocks
The stocks in a portfolio are those in an indexlike the S&P 500 and dozens of country or industry indexes
ETFs can be bought and sold continuously onan exchange like common stock
-
8/8/2019 3global Diversification and Asset Class[1]
41/57
R eal E state Investment T rusts(REIT s)
Investment fund that invests in a variety of real estate propertiesConstruction and development trusts
provide builders with constructionfinancingMortgage trusts provide long-termfinancing for propertiesEquity trusts own various income-
producing properties
-
8/8/2019 3global Diversification and Asset Class[1]
42/57
Direct R eal E state Investment
Purchase of a home
Average cost of a single-family house can beexpensive
Financing by mortgage requires down payment
Homeowner hopes to sell the house for cost plus a gain
-
8/8/2019 3global Diversification and Asset Class[1]
43/57
Direct R eal E state Investment
Purchase of raw land
Intention of selling in future for a profit
Ownership provides a negative cash flow due tomortgage payments, taxes, and propertymaintenance
R isk from selling for an uncertain price and lowliquidity
-
8/8/2019 3global Diversification and Asset Class[1]
44/57
-
8/8/2019 3global Diversification and Asset Class[1]
45/57
Direct R eal E state Investment
R ental Property
Acquire apartment buildings or houses with lowdown payments
D erive enough income from the rents to pay theexpenses of the structure, including the
mortgage payments, and generate a good return
R ental property provides a cash flow and anopportunity to profit from the sale of the
property
-
8/8/2019 3global Diversification and Asset Class[1]
46/57
Low-Li q uidit y InvestmentsSome investments dont trade on securitiesmarkets
Lack of liquidity keeps many investorsaway
Auction sales create wide fluctuations in
pricesWithout markets, dealers incur hightransaction costs
-
8/8/2019 3global Diversification and Asset Class[1]
47/57
Anti q uesD ealers buy at estate sales, refurbish, andsell at a profit
Serious collectors may enjoy good returns
Individuals buying a few pieces to decorate
a home may have difficulty overcomingtransaction costs to ever enjoy a profit
-
8/8/2019 3global Diversification and Asset Class[1]
48/57
Art
Investment requires substantial knowledgeof art and the art world
Acquisition of work from a well-knownartist requires large capital commitmentsand patience
High transaction costs
Uncertainty and illiquidity
-
8/8/2019 3global Diversification and Asset Class[1]
49/57
Coins and StampsEnjoyed by many as hobby and as aninvestmentMarket is more fragmented than stock market, but more liquid than art andantiques marketsPrice lists are published weekly and
monthlyGrading specifications aid salesWide spread between bid and ask prices
-
8/8/2019 3global Diversification and Asset Class[1]
50/57
D iamonds
Can be illiquid
Grading determines value, but is subjectiveInvestment-grade gems require substantialinvestments
No positive cash flow until soldCosts of insurance, storage, and appraisal
-
8/8/2019 3global Diversification and Asset Class[1]
51/57
H istorical R isk- R eturns on
Alternative InvestmentsW orld Portfolio Performance
R eilly and Wright (2004) examined the
performance of various investment alternativesfrom the United States, Canada, Europe, Japan,and the emerging markets for the period 1980-2001
-
8/8/2019 3global Diversification and Asset Class[1]
52/57
R eill y and W rig h ts 2004 Stud y
Asset R eturns and Total R isk The expected relationship between annual rates
of return and total risk (standard deviation) of these securities was confirmed
-
8/8/2019 3global Diversification and Asset Class[1]
53/57
R eill y and W rig h ts 2004 Stud y
R eturn and Systematic R isk The systematic risk measure (beta) did a better
job of explaining the returns during the periodthan did the total risk measure
The beta risk measure that used the Brinsonindex as a market proxy was somewhat better than the beta that used the S&P 500 Index
-
8/8/2019 3global Diversification and Asset Class[1]
54/57
R eill y and W rig h ts 2004 Stud y
Correlations between Asset R eturns U.S. equities have a reasonably high correlation
with Canadian and U.K. stocks but lowcorrelation with emerging market stocks andJapanese stocks
U.S. equities show almost zero correlation withworld government bonds, except U.S. bonds
-
8/8/2019 3global Diversification and Asset Class[1]
55/57
Art and Anti q uesMarket data is limited
R esults vary widely, and change over time,making generalization impossible, butshowing a reasonably consistentrelationship between risk and returnCorrelation coefficients vary widely,allowing for great diversification potentialLiquidity is still a concern
-
8/8/2019 3global Diversification and Asset Class[1]
56/57
R eal E stateR eturns are difficult to derive due to lack of consistent dataR esidential shows lower risk and returnthan commercial real estateD uring some short time periods R EITs haveshown higher returns than stock with lower risk measuresLong term returns for real estate are lower than stocks, and have lower risk
-
8/8/2019 3global Diversification and Asset Class[1]
57/57
Correlationrelative measure of agiven relationship