Monday, September 22, 2008
Value Investing Today: Chp 10: Unique Aspects of Global Investing
Posted by Reyer Barel
Brandes points out that although he recommends investors to participate in global investing, foreign investments are subject to currency exposure, political risks and different accounting standards than domestic investments.
Investment returns with global investments will depend on the change in price and the change in the relevant currency valuations. Brandes believes that exposure to foreign currencies provides another layer of diversification and is a good thing for value investors. However, he does not believe that value investors should engage in currency hedging for the reasons of 1) it is practically impossible to understand the true currency exposure for a given company, 2) the costs associated with currency hedging and 3) the potential for doing more harm than good in trying to hedge.
Brandes is a bottom up investor and for that reason he recommends looking across the globe to discover good quality companies selling at cheap prices prior to considering specific country related political risks. After a solid business investment is found, investors can change the required entry price for the investment to account for unique political risks. In general, Brandes recommends investors diversify away political risks by "limiting portfolio assets to the greater of 20% of portfolio assets or 150 percent of that country's weighting in a comparable index" (direct quote from Brandes). In this way, it offers flexibility to the investor as well as benefits of country diversification.
Accounting standards vary between different countries. Some countries don’t allow the two sets of financial statements like the U.S. and Canada allows, one for tax reporting purposes and one for financial markets. The implication is that for those nations, the net income may be understated. Other examples of differences between country accounting standards are some allow or even mandate faster rates of depreciation, some only recently allowed the recognition of goodwill on acquisitions and some amortize goodwill over short time periods. For these reasons, Brandes warns that directly comparing earnings and other related ratios (e.g. P/E) between companies in different countries is problematic. He does suggest that comparing cash flows from international companies is much more useful than comparing reported earnings, because they will be less distorted.
Brandes has the opinion that investors that have done the diligence and understand the different accounting treatments in different nations will have a decided advantage in valuing companies.