Tài chính doanh nghiệp - Finance 407: Multinational financial management - Topic 17: Foreign funds and global portfolio improvement

Topic #17: Foreign funds and global portfolio improvementL. GattisThe Pennsylvania State UniversityFinance 407: Multinational Financial Management1Review2The yen is selling at a 3% premium to the USD. Yen banks are lending yen at 1%. What is the USD cost of a yen loan?4.8%2.0%1.9%-1.9%4.0%Learning Objectives3Learning ObjectivesStudents understand and can recallthe benefits of foreign funds (vs. securities)alternative foreign investment funds Students can computeReturn or volatility improvement from global diversificationInternational Funds4Investment FundsAdvantages: Professional Management, Diversification, Reporting/Tax, Index Funds (Passive Index Matching)AdvantagesLow fees, Matches Index less feesStylesMajor Indexes (Nikkei, S&P500, NASDAQ, FTSE)Country Funds (WEBS)Regional Funds (EAFE, EMA, Frontier)World Equity Benchmark (IOO, ACWI, DGT)Sovereign and Corporate Bond Index FundsManaged Funds (Mutual Funds)AdvantagesProfessional Securities Selection, Possible outperformance of indexStylesCountry Specific Mutual FundsRegional Mutual Funds (Europe, Asia, etc.)Foreign Mutual Funds (World excl. U.S.) Global Mutual Funds (Includes U.S.)World Bond, Regional Bond, Corporate Bond, Sovereign BondElectronic Traded Funds (ETFs)5ETFs are index funds that are traded on exchanges like stocksETFs track published indices and thus require little management and offer low feesAnnual fees and costs are often less than 50 bps per yearLike stocks, ETFs can be bought intra-day, shorted, and bought on marginTop ETFs by Sizefinance.yahoo.com/etf (9/21/10)6Developed Countries (Incl. EAFE)7Emerging Markets (BRIC countries and others)8International “Managed” Mutual Funds9A U.S. investor can achieve international diversification by investing in a U.S.-based international mutual fund.Unlike ETFs, Mutual Funds employ active management techniques and try to find undervalued securities.Management fees are typically 100-200bps per years and often include a sales fee (load) when purchased or sold Morningstar Int’l Fund “Stand Outs”109/20/201011Sales Commissions (Sales Load)Class A: Front-end loadLoad added to Net Asset Value (NAV) when purchased (8.5% Max)Value of Securities / Share OutstandingE.g., Invest $1000 with 5% load – only $950 is investedClass B: Back-end “deferred” load Load subtracted when sell fundSome back-end loads fall to zero for longer holding periodClass C: No load, but have annual 12b-1 fees (which includes advertising and promotion fees), Max 1% annuallyOperating expenses (Management Fees and Expenses)Range from 0.2 to 2.0% per yearNot charged directly to investor (deducted from NAV)Fees and performanceLoads are not included in fund performance; 12b-1 “marketing fees”, management fees, and other operating expenses are included in “operating expenses”Mutual Funds Costs12A First Look at Mutual Fund PerformanceEvidence shows consistent poor performance.A majority of domestic funds underperformed the Wilshire 5000 in 20 of 28 years testedFunds that perform in top half in one year, have about a 50% chance of finishing in the top half in the following year.There is evidence that some funds show consistent strong performance.Depends on measurement intervalLow costs are a characteristic of strong performersGlobal Portfolio Return or Volatility Improvement13How much return or volatility improvement could be achieved by moving from a domestic (D) to global (G) portfolio?I collected return data for U.S., EAFE, and Emerging Market equity returns from 10/03 to 9/10.I then compared the USD returns and standard deviation of U.S. stocks to a global portfolio (50% US, 40% EAFE, 10% EM)The Sharpe Ratio {(rp-rf)/σ} uses a Risk-Free rate of .5%S(SPY)= (.043-.005)/.155=.24Sharpe Ratio and Capital Allocation Line14Portfolios that combine G and Rf will dominate portfolios that combine D and Rf.RσRfDGEquation of a Line and CAL15Equation of a LineYXBY=B+MXM=SlopeCapital Allocation Line RσRfR=Rf+SσIf Rf=1% and S=.4; What return could you earn on a portfolio with 10% standard deviation? A. 5% B. 11% C. 4% D. 10.4%σ=(R-Rf)/SX=(Y-B)M1%M=.4Equation of a Line and CAL16Equation of a LineYXBY=B+MXM=SlopeCapital Allocation Line RσRfR=Rf+SσIf Rf=1% and S=.4; What standard deviation could you earn on a portfolio with 8% expected return? A. 4.2% B. 9% C. 11.2% D. 17.5%σ=(R-Rf)/SX=(Y-B)M1%M=.4Domestic v. Global Equity Portfolio17If I desired a 16% standard deviation, how much of a return improvement could I achieve by moving from domestic (D) to global (G) portfolio?Return Improvement(Target Volatility: 16%)18rσ8%2%RfD18%9%G16%Target VolReturnImprovementUsing the capital allocation line (CAL), the return for the global portfolio (G) and domestic portfolio (D) are as follows. Assume you can borrow and invest at rf“Y=b+MX”rD= A. 2.57% B. 4.34% C 5.74%rG= A. 6.58% B. 8.47% C. 3.25%Ret Improvement = rG - rD5%rD=rf+.24σDrG=rf+.38σG.5%Portfolio Value at Retirement19If you invest $10,000 a year for 45 years at a domestic rate of 4.34%, you will have $1,328,412 at retirement. How much will you have if you invest in the global return of 6.58%A. $1.5M B. $2.0M C. $2.5M D. $3.0MConstructing the Global CAL Portfolio(Target Volatility: 16%)20r8%2%RfD18%9%G16%Target VolReturnImprovementrG=rf+SGσ*=.005+.38*.16=6.58%How do I construct the global portfolio?The volatility of a portfolio that combines G and Rf is 16%. Solve the portfolio volatility formula for the weight in GPortfolio Volatility = WRiskyσRisky.16 = WG(.178)WG= .90; Wrf= (1- WG)=1-.9=.10If you have $100 to invest, put $90 in G and $10 in Rf (Treasuries)6.58%4.34%5%rD=rf+.24σDrG=rf+.38σG.5%Caveats21Improvements shown in the example are due to the historical Sharpe values which show that the global portfolio has had a better excess return/risk ratio over that period (2003-2010)This may not always hold for individual years or longer periods of timeHowever, many financial advisors and financial research suggest that a portfolio should include at least 20-30% invested in diversified foreign fundsWarning: Correlations are increasing – the diversification benefits are erodingiClicker: Class EvaluationHow would you rate today’s class? Highest Lowest22Assigned Problems23Assume that a global portfolio has an expected return of 8% and standard deviation of 16%. A domestic portfolio has an expected return of 6% and standard deviation of 14%. The risk free rate of return is 1%. What is the global return improvement if an investor desires a 10% standard deviation? What are the portfolio weights in the global portfolio and risk free asset to achieve the targeted standard deviation? Equation of Capital Allocation Line (connecting risky and Rf); Return = Rf + Sharpe(Of Risky Portfolio) * SD Sharpe(G) = (R(G)-R(f))/SD(G)= (.08-.01)/.16=.4375; Sharpe(D) = = (R(D)-R(f))/SD(D) (.06-.01)/.14=.357 Ret(G, 10% Vol) = .01+.4375*.1=.05375; Ret(D, 10% Vol) = .01+.357*.1=.0457; Improvement = 5.375% - 4.57% = .805% SD(Risky +Rf Asset) = Weight(Risky)*SD(Risky); Weight(Risky)= SD(Risky +Rf Asset)/SD(Risky) W(G)=.1/.16=62.5%; W(rf)=1-62.5% =37.5%