Think Global Invest Global

The move toward global investing is rapidly becoming more common even as some investors are doing so reluctantly and with caution. It may be difficult to know if the computer based financial plans used by many FAs for clients will include heavy allocations overseas. After all most of these models are based on old sector performance data that may not be either forward looking or contemporary.

One theme borrowed and modified from the New York Times, Thomas Friedman: "The investment world is flat.''

As of March 2007 the combined European market capitalizations eclipsed that of the United States for the first time in modern history. Further, owing to reforms of Sarbanes-Oxley stemming from accounting malfeasance after the U.S. stock market fell in 2000 [Enron, WorldCom, and so forth], London has now surpassed New York as the premier financial center. London doesn't have these protections or requirements and so companies wishing to go public may do so there. And they have.

In the United States, ETF issues geared to overseas investing has grown faster than any other sector. Popular [EFA] MSCI Europe, Asia, and the Far East is now the second or third largest ETF in terms of assets in the United States. Other overseas ETFs are also extraordinarily popular including: [ILF] Latin America ETF, [EEM] MSCI Emerging Markets ETF, and single country funds like [EWA] Australia, [EWJ] Japan, and [EWW] Mexico to name just a few. Mostly listed on the American Stock Exchange [AMEX], many of these ETFs, particularly in the single-country fund area have existed for quite some time but languished with little trading volume during the 1990s as investors focused on the U.S. stock market boom. Just on the AMEX alone there are more than 50 such overseas oriented issues. The New York Stock Exchange [NYSE], not to be left out of the game, is becoming more competitive with dozens of new issues listed there as well.

Furthermore, many overseas ETFs are becoming more specialized in subsectors with diverse issues focused on value, small-cap, and dividend models, for example. Therefore investing overseas is becoming like that in the United States with nearly as many different approaches there as in the United States.

Why is this focus overseas occurring? One thing that hasn't been discussed frequently as a stimulus revolves around the end of the Cold War. Until the Soviet Union collapsed in 1990 Europe was divided between Eastern and Western Bloc countries not just politically but economically. After the fall, it didn't take as long as some felt for the European Union to be formed and the subsequent single currency, the euro, replaced many different currencies from German deutsche marks to Spanish pesetas. This more homogenous economic structure unencumbered by Cold War politics and attendant economic barriers freed individuals and business to seek economic growth.

Also previous to the collapse of the Soviet Union, much of the world apart from Europe was also either with the West or the Soviets. Even the so-called "non-aligned" nations were primarily with the Soviets. Here, too, after the Soviet collapse, many nations whether in Asia or Latin America were also freed from the political constraints of Cold War politics. They could move forward with economic growth and most did.

In the fall of 2006, our newsletter The ETF Digest [www.etfdigest.com] began a series of quarterly podcast interviews with well-regarded London research firm the Emerging Markets Monitor [EMM]. [These interviews are available for listening without cost or registration from our public homepage.] They presented a core argument of a ''convergence story'' taking place among all global markets especially including Emerging Markets. The basis or theme is that many markets previous to around 2000 were valued at pre-Cold War levels and were deemed too economically backward, corrupt, and too volatile for consistent investment results.

Even when evaluating credit risk it was common before and during the global bear market of 2000-2002 that spreads [the difference in yield between Emerging Market debt and, say, U.S. Treasury debt] to be more than 200 to 300 basis points. That is, if U.S. Treasury bonds were yielding 7 percent, Emerging Market debt would need to yield 9 to 10 percent for buyers. Today this is changing. Interest rate spreads are narrowing to half the previous levels. Why? Some of this [others might argue "all"] is due to the high levels of global liquidity needing and perhaps rationalizing a home. But equity markets too were leading the way higher. In fact, the succeeding equity bull market returns in established markets [whether in the United States or established overseas markets] were dwarfed by returns garnered by Emerging Markets.

In the United States, 9/11 had many overseas investors perceiving the event as primarily a U.S. problem. The war between radical Islam and the West would have to be fought by the United States. It was regarded callously as not a problem for the rest of the world including Asia [led by China and India] to Latin America. So while the United States fought an economically costly war the rest of the world got on with their business.

The evidence is clear and is clearly demonstrated by performance history as demonstrated in Figures 7.1 through 7.7. First, let's look at returns from mainstream United States and some established overseas markets.

While the established markets turned in excellent performances during this four-year post-bear market period, you'll note the clear superior performance of Germany versus its established market peers.

During the same period, other overseas market ETFs—especially in the Emerging Market sector—did much better than their established market counterparts, especially in the United States. Furthermore these have been the leaders in both performance and popularity over the same investment period. See Figures 7.8 through 7.10.

There were individual single-country ETFs that performed as well or better than even the broad regional issues, shown in Figures 7.11 through 7.14. And no, I'm not just cherry-picking the best ones. Is it any wonder that overseas investing is popular, given the evidence of superior performance?

Austria has benefited from the end of the Cold War and the European Union [EU]. It is regarded now as the financial center for emerging and former Iron Curtain countries. Spain and other smaller economies within the EU have prospered with the new financial integration. Spain even had to abandon its popular siesta practice of closing shop and taking several hours off while the rest of Europe was working. Imagine hard working Germans calling Madrid for business in the afternoon and finding them "out to lunch.'' The work obsessed Germans weren't going to tolerate that.

The "Chindia" [China and India] story continues to captivate investors and much of the growth in other markets stems from the economic vibrancy and demand sourced to these two countries.

FIGURE 7.1 Monthly Chart S&P 500 ETF Source: Chart Courtesy of StockCharts.com.

Latin America prospers as it is able to meet the demand for raw materials globally from China and India. Australia's market is booming since it, too, is a supplier of key minerals to feed the appetite also from the same source.

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