international portfolio diversification

INNOCENTS ABROADInternational Diversification

Andrea GherziLucrezia Grasso Mustafa KhanHeathcliff Lewis

Innocents AbroadInnocents Abroad

Agenda2

Firm’s Strategy Global Equity Markets Performance Correlation Analysis Impact of currency movements Portfolio Allocation


Agenda3


Innocents AbroadInnocents Abroad4

CapGlobal Advisors, LLC

Equities, Fixed Income and FX Portfolio Management

Focus on International Diversification Better risk-return tradeoff Diversifying across nations with different

economic cycles Better returns with lower systematic risk

than domestic portfolios


Agenda5



Global Equity Markets Performance66

0

500

1000

1500

2000

2500

3000

3500

D-80 M-82 O-83 M-85 A-86 J-88 J-89 N-90 A-92 S-93 F-95 J-96 N-97 A-99 S-00 F-02 J-03

Market Indices (Local Currency)

Australia

Canada

France

Germany

Hong Kong

Japan

U.K.

U.S.0

500

1000

1500

2000

2500

3000

D-80 A-82 A-84 N-85 J-87 M-89 N-90 J-92 M-94 N-95 J-97 M-99 N-00 J-02

Market Indices (Dollars)

Visible Dotcom bubble Strong U.S. performance


Global Equity Markets Performance

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Index Returns (Dollars)

-40%

-30%

-20%

-10%

0%

10%

20%

30%

Index Returns (Local Currency)

Australia Canada France Germany Hong Kong Japan U.K. U.S.

Emerging Markets VolatilityCanada highly correlated with Dollar




Annualized Mean 12.85% 11.59% 15.33% 11.56% 17.58% 6.77% 14.80% 14.05%Std 18.56% 15.52% 20.74% 19.57% 30.69% 19.25% 16.65% 15.53%


Annualized Mean 10.90% 12.85% 12.25% 9.72% 16.24% -0.48% 10.40% 11.77%Std 12.69% 14.87% 19.46% 20.29% 29.57% 18.73% 14.74% 15.08%

1981 - 2003

1981- 1991

1992- 2003

Risk-Return Characteristics (Local Currency)







1992- 2003

1981- 2003

1981- 1991

Risk-Return Characteristics (Dollars)


Agenda10



Correlation Analysis11

Why Correlation is Important? Measure interactions of different

markets

Determine diversification benefits

Correlation between U.S and other Markets

Correlation among International Markets


Correlation 1981-2003 Local Currency

Correlation Analysis

Australi

a Canada France Germany

Hong Kong Japan U.K. U.S.

Australia 1

Canada 0.5881 1

France 0.4135 0.5341 1

Germany 0.4288 0.5112 0.7144 1

Hong Kong 0.4720 0.4782 0.3739 0.4483 1

Japan 0.3252 0.3795 0.3986 0.3506 0.2771 1

U.K. 0.5342 0.6317 0.6113 0.5986 0.5430 0.4032 1

U.S. 0.5074 0.7795 0.5910 0.5833 0.4485 0.3799 0.7060 1

Currency Risk?

12



Australi

a Canada France Germany

Hong Kong Japan U.K. U.S.

Australia 1

Canada 0.5958 1

France 0.3875 0.4672 1

Germany 0.3778 0.4423 0.7294 1

Hong Kong 0.4713 0.4794 0.3303 0.3903 1

Japan 0.3339 0.3487 0.4108 0.3433 0.2661 1

U.K. 0.5489 0.5892 0.5972 0.5716 0.4819 0.4520 1

U.S. 0.4733 0.7646 0.5226 0.5079 0.4349 0.3253 0.6125 1

Correlation 1981-2003 Dollars13


Comparison 1981 - 2003

Lower Correlation Higher Returns VolatilitySimilar Market Risk

Local Currency

Correlation with

U.S

Reutrns Volatility

Beta

Australia 0.5074 18.56% 0.6065

Canada 0.7795 15.52% 0.7791

France 0.5910 20.74% 0.7896

Germany 0.5833 19.57% 0.7353

Hong Kong 0.4485 30.69% 0.8866

Japan 0.3799 19.25% 0.4710

U.K. 0.7060 16.65% 0.7569

U.S. Dollars

Correlation with

U.S

Reutrns Volatility

Beta

Australia 0.4733 23.44% 0.7144

Canada 0.7646 17.82% 0.8778

France 0.5226 21.75% 0.7322

Germany 0.5079 20.73% 0.6780

Hong Kong 0.4349 31.64% 0.8862

Japan 0.3253 23.96% 0.5019

U.K. 0.6125 18.39% 0.7256



Correlation is time varying!

Positive Trend: correlation is increasing in time

1981 – 1991 1992 - 2003

Local

Currency U.S Dollars Local Currency U.S Dollars

Australia 0.4715 0.6197 0.3921 0.6142

Canada 0.7776 0.7859 0.7466 0.7855

France 0.5030 0.6871 0.4263 0.6561

Germany 0.4533 0.7022 0.3603 0.6698

Hong Kong 0.3463 0.5559 0.3287 0.5547

Japan 0.3815 0.3738 0.2819 0.3671

U.K. 0.6904 0.7289 0.5663 0.6981




Correlation with U.S market in Local Currency

D-82D-8

3D-8

4D-8

5D-8

6D-8

7D-8

8D-8

9D-9

0D-9

1D-9

2D-9

3D-9

4D-9

5D-9

6D-9

7D-9

8D-9

9D-0

0D-0

1D-0

2D-0

3

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Australia Canada France Germany Hong Kong Japan

16


Correlation AnalysisCorrelation with U.S market in Dollars

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

Australia Canada France Germany Hong Kong Japan

17


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-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

5%

7%

9%

11%

13%

15%

17%

19%

21%

23%

25%

S&P 500 returns EAFE EAFE $ S&P 500 Volatility

Co

rre

lati

on

Valu

es

Sta

nd

ard

De

via

tio

n

123456789101112131415161718192021222324252627282930313233343536373839404142434445464748495051525354555657585960616263646566676869707172737475767778798081828384858687888990919293949596979899100101102103104105106107108109110111112113114115116117118119120121122123124125126127128129130131132133134135136137138139140141142143144145146147148149150151152153154155156157158159160161162163164165166167168169170171172173174175176177178179180181182183184185186187188189190191192193194195196197198199200201202203204205206207208209210211212213214215216217218219220221222223224225226227228229230231232233234235236237238239240241242243244245246247248249250251252253

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

5%

7%

9%

11%

13%

15%

17%

19%

21%

23%

25%

S&P 500 returns EAFE EAFE $ S&P 500 Volatility

Co

rre

lati

on

Valu

es

Sta

nd

ard

De

via

tio

n



Agenda19



Impact of Currency Movements20

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

Total spread Equity Ret


Risks and Mitigation21

Exchange risk Hedge portfolio using forward exchange

contracts, swaps etc Political risks

Exchange rate effects can be hedged


Agenda22



International Portfolio Allocation

S&P 500 EAFE $ Return Stdev Return Stdev Return Stdev100% 0% 13.40% 15.51% 15.71% 16.37% 11.29% 14.70%80% 20% 13.04% 14.67% 16.02% 15.28% 10.31% 14.09%60% 40% 12.68% 14.45% 16.33% 15.05% 9.34% 13.86%50% 50% 12.51% 14.59% 16.49% 15.28% 8.86% 13.90%

1981- 2003 1981- 1991 1992 -2003Portfolio Allocation

23



-30%-25%-20%-15%-10%

-5%0%5%

10%15%20%25%30%35%40%45%

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

US vs International Market Performance YOY

EAFE S&P 500 EAFE $

24



25

14.00%

16.00%

18.00%

20.00%

22.00%

24.00%

26.00%

28.00%

30.00%

32.00%

34.00%9.00%

10.00%

11.00%

12.00%

13.00%

14.00%

15.00%

16.00%

AustraliaCanada

France

Germany

HK

Japan

UKUS

1981 - 2003

Annualized Standard Deviation

Annualized R

etu

rn

Portfolio Allocation

Australia

Canada

France

Germany

Hong Kong

Japan

U.K.

U.S.

international portfolio diversification

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