Global Investing: Benefits, Risks, and Approaches

Dr. Raj Aggarwal, CFA Sullivan Professor of International Business and Finance University of Akron, Akron, OH 44325; 330-972-2780; [email protected]

October 30, 2010 Westlake Porter Library Dr. Raj Aggarwal, CFA

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Outline • Nature of the Great Recession - Recovery • Economics of Globalization & Technology • Approached to Global Investing

Dr. Raj Aggarwal, CFA

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Current Business Outlook • Industrial economies coming slowly out of the great recession due to the bursting of financial bubbles • Double dip recession risk seem to have subsided. Some danger of currency wars • Growth has resumed in developing markets, but Chinese growth may slow • US exports are rising fast but imports still larger • US and Europe growth 1-2%, China/India 8-9%, Brazil, Africa, Eastern Europe/Russia at ~5%. Dr. Raj Aggarwal, CFA

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Nature of this Great Recession • Post-1989 Deregulatory and Debt Binge • Tech and Globalization of Problems • Reset-Related Uncertainty in New Normal

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Understanding the Great Recession

• Nature of this Mess and Who’s Responsible • New Reset - Cyclical+Secular Changes • The Long Climb Back

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Who’s Responsible? (the Blame Game) • • • • •

Greedy Bankers and Sleepy Regulators Righteous Ideologues like Alan Greenspan Those Darn Foreigners – Savers Look in the Mirror!! Continuing deregulation since 1989 – Unconstrained Keynsian Animal Spirits Dr. Raj Aggarwal, CFA

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Cyclical or Secular Changes? •

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Both Cyclical Recession overlaid with three major trend changes: Technology, Globalization, and OPM (debt) Addiction Unemployment mainly among non-college and middle management – all related to tech changes – so it is likely to be long-term Discretionary (consumer and business) spending is down; Value is again the king! A permanent shift in consumer and business behavior (a reset to a new “value” normal)? Dr. Raj Aggarwal, CFA

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Technology and Globalization Tech Moore’s Law - the overthrow of matter Internet – Global Connectedness Nature of work changing – less observable Globalization 1989 Decline of Socialism – Rise of Markets Reduced barriers/costs – Global Village Wealth creation – Specialization/Trade The Rise and Rise of the BRICS Dr. Raj Aggarwal, CFA

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The Information Technology-Globalization Virtuous Circle

Technology Revolution Tech - Microprocessors, Communications, Biotech, New Materials, Lighter Products, Mass - Shift from Physical to Weightless Intellectual Factors of Business

Technology Facilitates Globalization of Business

Globalization Ideology - Triumph of Market-Driven Capitalistic Systems and Consumer Power Demography - Mature versus Developing Country Age Distributions and Demand Wealth Creation - Specialization and Trade; Diversification and Investment Mechanism - Rise of Technology Enabled Multinationals and Global Commerce

Globalization Makes Technology More Profitable and Innovations Faster

Source: Aggarwal, R. (1999), “Technology and Globalization Mutual Reinforcers in Business: Reorienting Dr. Raj Aggarwal,as CFA 10 Strategic Thinking for the New Millennium” Management International Review 39 (No. 2), pp. 92-104.

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The New Landscape • There are no domestic businesses. All US Business are now competing with businesses from Canada, Mexico, China, India; Any country in the world really. • Only need internet connections and a hungry and educated workforce; Knowledge is easily available; Capital and land don’t really matter so much; In fact, natural resource wealth is often a curse for a country. • Deleveraging and Value orientation is likely for business (with many side effects). The era of unfettered free markets since the fall of the Berlin Wall is now firmly reversing course globally with greater government regulation globally. Dr. Raj Aggarwal, CFA

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Sources of Hope • Emerging markets are already recovering; Chindia never really suffered • There are some stirrings of recovery even in the developed economies like the US; Australia has already raised interest rates • There remain lots of opportunities for growth – Businesses need to provide solutions to major problems – mostly at the intersection of social and technological trends Dr. Raj Aggarwal, CFA

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Recession: Looking Ahead • Recession related to Tech, Globalization, and Deregulation-led Debt Binges • Long Recovery Period - Already Starting • But, Cannot Go Back – Will be a Reset • More Regulation Going Forward • Many New Opportunities for Growth • How Is Your Portfolio Positioned for This? Dr. Raj Aggarwal, CFA

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Opportunities: Global Challenges • As the Chinese say: Risk/Opportunity are Two Sides of the Same Coin – They are Linked • Emerging Markets: High growth countries like China, India, Brazil, and others in Latin America, Asia, Eastern Europe, and Africa. Also have high risks. • Borders disappearing – really! Declining transportation costs, increasing travel, cheap or free international communications; rise of the internet, etc. This creates both risks and opportunities • Bio-Contagion: Bugs travel free – invasion by foreign flora and fauna; e.g., Asian carp in Lake Michigan, Fire ants in the mid-west, etc; HIV, Swine Flu, etc; Implications and opportunities for sterilization, containment, and destruction of bugs Dr. Raj Aggarwal, CFA

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Opportunities: Global Challenges (2) • Demographics: Too many old people and not enough youngsters especially in industrial countries – rising life expectancies and declining fertility - problem most severe in countries like – Italy and Japan but others not far behind, e.g., US, Europe, and China. Young people will mostly be in emerging markets but will be needed in the Triad. Future growth in these countries likely limited by lack of human resources. • This creates Opportunities for distance education, offshore jobs, and other young people needs; also need for offshore health care, travel, sports, entertainment, and for other old people needs Dr. Raj Aggarwal, CFA

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Opportunities: Global Challenges (3) • Warfare: Many desperados always ready to fight; New forms like terrorism - gorilla warfare crosses borders; Opportunities in new more accurate weapons; Space warfare, Weapons detection and personnel screening; Facility and people protection; Financial controls; Internet attacks/defense, etc. • Pollution: Gas emissions and other pollutants cross borders and cross oceans; e.g., Chinese pollution detected over US skies; International cooperation needed to control; expanding global market for pollution control Dr. Raj Aggarwal, CFA

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Opportunities: Global Challenges (4) • Sustainability: Limits on trash dumps and resource availability; need to re-cycle; Driven by more than economics; Europe and CA in forefront; Huge opportunities in sustainability • Climate Change: Too many green house gas (GHG) emissions; Global temperature rising; may or may not be connected but drivers are not just economics; Europe and CA at forefront; Huge opportunities in alternate energy, Carbon capture/storage; white roofs and parking lots, building insulation; etc. Dr. Raj Aggarwal, CFA

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Opportunities in Global Challenges • Technology and Globalization are Mutually Reinforcing Obliterating Most Border Effects. This Opens Up Every Economy, Business, and Individual to Global Competition. • Can be Challenging but Creates Many Global Problems that Require Solutions. As the Chinese say: Risk/Opportunity are Two Sides of the Same Coin. Many Opportunities Globally; especially in high growth emerging markets. • How is your Portfolio Positioned to Gain From These Opportunities? Dr. Raj Aggarwal, CFA

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Approaches to Global Diversification • I. Asset Allocation – How Much Global? • II. Four Approaches Stocks Listed on Foreign Exchanges Foreign Stocks Listed/Traded in the US Global and International Mutual Funds US Multinationals Dr. Raj Aggarwal, CFA

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Why are Native-Americans Called Indians? • In 1750, China and India each accounted for about 25% of global manufacturing output (together Chindia was 50%, and the global economic center) • Then we had the Industrial Revolution and 250 years of European/US hegemony and Chindia, ruled by western powers, declined greatly • In 1492, Columbus was looking for a shorter route to these rich eastern lands – so he called the natives he found after his long voyage – Indians! • So, now I am a Cleveland Indian!? Dr. Raj Aggarwal, CFA

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G7 Share of the Global Economy - 2010

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Global Economic Architecture

How is your company positioned to take advantage? Dr. Raj Aggarwal, CFA

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Asset Allocation • Asset allocation can reflect country shares of global markets. US Share of global markets declining; shares of emerging markets small but rising. • Asset allocation can reflect country shares of economic growth – more in the rapidly growing markets of China, India, Brazil, etc. • Can overweight selected high growth countries. Dr. Raj Aggarwal, CFA

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Stocks Listed on Foreign Exchanges • Almost every country now has a stock exchange; but many are inefficient and can be manipulated by selected insiders. • Difficult to follow foreign stocks – lack of comparable and sufficient information. Often huge differences in cultural, linguistic, legal and political systems • Custody and clearance of securities difficult and time consuming; brokerage costs for such transactions high. Dr. Raj Aggarwal, CFA

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Foreign Stocks Traded in the US • Over 3200 foreign shares are traded in the US as ADRs on the NYSE, NASDAQ, OTC, and Private Markets (e.g., Sec. 144). • Most information is available on Level I ADRs (NYSE or NASDAQ); less for Level II ADRs (OTC) and least for the others. • About 400 Level I ADRs trade on the major US exchanges (NYSE or NASDAQ). These have appropriate Stock symbols etc. Dr. Raj Aggarwal, CFA

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3269 US ADRs for Each Country Distribution of ADRs by Country

350 300 250 200 150 100

Z am bia Venez uela UK U nited Arab Em irate s U k raine T urk ey T unis ia T hailand T aiw an Sw itz erland Sw eden Sri Lank a Spain South Afric a Singapore R us s ia R om ania Q atar Portugal Poland Philippines Perú Pak is tan O m an N orw ay N igeria N ew Z ealand N etherlands M oroc c o M éx ic o M alta M alay s ia M alaw i M ac au Lux em bourg Lithuania Lebanon Latv ia Kuw ait Korea Kaz ak hs tan J ordan J ers ey J apan J am aic a Italy Is rael Ireland Indones ia India H ungary H ong Kong G reec e G erm any G eorgia F ranc e F inland Es tonia Egy pt Ec uador D enm ark C z ec h R epublic C y prus C roatia C olom bia C hina C hile C hannel Is lands C ay m an Is lands Bulgaria Braz il Berm uda Belgium Banglades h Bahrain Aus tria Aus tralia Argentina

50 0

Total ADR

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US ADRs – Country Distribution COUNTRY

Level 3

Level 1

Level 2

India

16

4

294

314

Japan

21

249

1

271

China

95

137

12

244

United Kingdom

49

180

15

244

Australia

10

174

8

192

Russia

6

42

143

191

Hong Kong

6

140

4

150

37

51

51

139

Taiwan

8

1

111

120

France

9

71

6

86

South Africa

6

67

7

80

Ukraine

0

11

64

75

Germany

7

65

Singapore

1

68

1

70

Italy

7

38

11

56

México

20

21

14

55

Korea

9

8

37

54

Turkey

1

23

30

54

Sweden

1

44

Poland

0

17

27

Brazil

Total ADR

72

45 44

Switzerland

6

33

1

40

Spain

4

32

3

39

Argentina

17

7

11

35

Netherlands

10

22

3

35

Kazakhstan

0

2

27

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COUNTRY

Level 3

Level 1

Level 2

New Zealand

1

28

Norway

2

27

Indonesia

2

23

2

27

Ireland

10

15

2

27

Belgium

2

23

1

26

Greece

3

17

6

26

Egypt

0

4

21

25

Finland

1

22

2

25

Austria

0

21

3

24

Denmark

2

20

Israel

5

11

5

21

Philippines

1

12

7

20

Portugal

1

17

2

20

12

1

6

19

Thailand

0

17

1

18

Hungary

1

4

9

14

Pakistan

0

Colombia

2

Georgia

0

Luxembourg

2

Chile

6

Total ADR 29 29

22

14

14

5

13

12

12

7

1

10

1

10

Venezuela

0

9

Malaysia

0

9

Nigeria

0

Perú

1

4

4

9

Dr. Raj Aggarwal, CFA Others

1

14

62

77 28

Total

395

1818

1056

9 9

9

3269

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400 Level I US ADRs Distribution of Level 1 US ADRs 100 90 80 70 60 50 40 30 20 10 0

Series1

Venezuela Ukraine Thailand Poland Pakistan Kazakhstan Georgia Egypt Austria Turkey Sweden Singapore Portugal Philippines Perú New Hungary Finland Norway Luxembourg Indonesia Denmark Colombia Belgium Greece Spain Israel Switzerland South Africa Russia Hong Kong Italy Germany Taiwan Korea France Netherlands Ireland Australia Chile India Argentina México Japan Brazil UK China

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Global and International Mutual Funds • Hundreds of mutual funds invest in non-US stocks and bonds (International) and in non-US and US stocks and bonds (Global). • Many are closed-end (including ETFs) and so trade on stock exchanges like a stocks and have symbols. Others are open ended and must be purchased from the mutual fund or its representatives. • Many are focused on a country or region while others have wider mandates. • All provide professional managers who specialize in international investing, but at a cost (between 1% and 2% per year) Dr. Raj Aggarwal, CFA

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Profits from the Rest of the World/Total Corporate Profits (%), 1960-2008 0.45 0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 2008

2005

2002

1999

1996

1993

1990

1987

1984

1981

1978

1975

1972

1969

1966

1963

1960

Series1

Source: US Department of Commerce, Bureau of Economic Analysis

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Foreign Sales of Selected US Companies-2009 Company

Percent Foreign Sales

Company

Percent Foreign Sales

Exxon-Mobil Conoco-Phillips GE P&G ADM Ford Caterpillar Intel Johnson & Johnson Pfizer Dow Citi AIG HP IBM Apple Amazon Microsoft Dell Coca-Cola Pepsi

47 38 54 61 49 54 67 85 50 57 68 39 60 64 64 48 48 43 47 74 48

Intel Coca-Cola Dow Caterpillar HP IBM P&G AIG Pfizer Ford GE Johnson & Johnson ADM Amazon Apple Pepsi Dell Exxon-Mobil Microsoft Citi Conoco-Phillips

85 74 68 67 64 64 61 60 57 54 54 50 49 48 48 48 47 47 43 39 38

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US Multinational Companies • Many US companies obtain ever larger proportions of their sales and profits from outside the US. Buying their shares provides global diversification for a portfolio. • Country distribution of investments by companies are not upto individual investors but is determined by senior corporate management. Dr. Raj Aggarwal, CFA

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Conclusions • The recent great recession is likely to be long-lived and restructure the US economy • While the US is expected to grow a bit faster than Europe or Japan, the greatest growth over the next 5-10 years is in Emerging markets like China, India, & Brazil; and over a longer horizon (10-15 years) in Africa and in selected countries in other regions. • There are at least four major approaches to global diversification. Choice between them depends on investor knowledge and risk appetite. Dr. Raj Aggarwal, CFA

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