Wednesday, September 17, 2008

Value Investing Today: Chp 8: Why Go Overseas

In this chapter, Brandes begins to focus on the topic of investing globally. He suggests some reasons to consider investing overseas including 1) you have more selection, 2) you can often find better opportunities abroad than in your domestic market (because most of the world's businesses are outside your domestic market) and 3) you can reduce risk by finding undervalued companies.

In 2001, a study by Yale University professors shows that the return correlation between U.S. and non U.S. stocks is cyclical in nature. This implies that the portfolio diversification benefits available by investing internationally are not constant over time. During some periods, the correlation of returns are high, indicating limited diversification benefits and during other periods, the correlation is low, indicating diversification benefits are more prominent. For this reason, Brandes advises to always maintain enough portfolio international equity exposure in order to capitalize on opportunities in other parts of the world while reducing risk.

Some investors believe that investing in U.S. multinational companies (companies that are headquartered in the U.S. but bring in significant foreign revenues) offers the same diversification benefits as investing with foreign equity securities. Brandes doesn't believe this is the case and references a study conducted between 1985 and 1998 that shows U.S. multinationals had a high correlation (0.89) with the S&P 500 Index. Over the same time period, the MSCI EAFE Index (a measure of returns in developed markets outside the U.S.) had a much lower correlation (0.48) with the S&P 500 Index. This suggests that U.S. multinational companies are not a good substitute for non U.S. stocks included in the MSCI EAFE Index. Brandes recommends to buy companies abroad to obtain meaningful international diversification benefits for your portfolio.

Brandes references another study which demonstrates the cyclical nature of international currency valuations relative to each other. This study included the British Pound, the Japanese Yen, the European Euro and the U.S. dollar. Since relative currency valuations tend to vary over time, Brandes recommends maintaining adequate exposure to international currencies in order to provide the opportunity for currency appreciation and diversification benefits in a portfolio.

Brandes believes that the single most important factor for reducing security equity risk is buying a good company at a favourable price. For this reason, he does not advocate taking a top down approach in deciding which country to invest in. Rather, he recommends taking a bottom up approach and selecting the best opportunities around the world.

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