chapter 12 internationalization of mutual funds viewing recommendations for windows: use the arial...

Chapter 12Internationalization of Mutual Funds

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Market Capitalization, in $ Billions

U.S. Japan U.K Total

Developed Total

Emerging World

1980 1,448 380 205 2,552 186 2,738

1984 1,863 667 243 3,296 146 3,442

1988 2,794 3,907 771 9,240 489 9,728

1992 4,485 2,399 927 9,922 913 10,835

1996 8,484 3,089 1,740 17,933 2,226 20,159

2000 15,104 3,157 2,577 29,521 2,740 32,260

Source: SIA 2001 Securities Industry Fact Book

Size of Global Equity Markets


Source: Reprinted by permission. Goldman, Sachs Global Investment Research.

Note: Excludes emerging markets.

Increasing Importance of Global Sector versus Local Market


Gross Transactions in Foreign Stocks by U.S. Investors$ Billions

Source: SIA 2001 Securities Industry Fact Book

0

500

1,000

1,500

2,000

1986

1988

1990

1992

1994

1996

1998

2000

Europe

Asia

Latin Am. &Caribbean

Canada


Challenges of Foreign Investing

• Investment issues– Conducting research on foreign

companies– Restrictions on shareholders’

role in foreign companies

• Trading costs– Illiquidity of foreign markets– Difficulties in obtaining prices

• Regulatory issues– May need government

permission to buy securities– May be caps on foreign

ownership

• Currency Risk– Exchange rate fluctuations

increase return volatility

• Political Risk– Government policies may

change toward foreign investors– Unexpected political problems

may increase market risk

• Operational Risk– Some markets use physical

stock certificates– Some markets do not have

centralized / efficient settlement


Benefits of Investing Through Mutual Funds

• Reduced administrative costs = key reason for investing in an international mutual fund versus investing directly in foreign securities

• Fund managers can use their size to constrain high transaction costs of foreign markets

• Fund managers can obtain more information on foreign companies than most individual investors


Benefits of Investing Through Mutual Funds (cont.)

• Fund custodians can better obtain proxies, receive dividends, pay transaction taxes, and transfer stock certificates in foreign countries

• Still exposed to political and currency risk, although some funds try to reduce or eliminate currency risk by hedging


Flows Into U.S. Foreign Equity Mutual Funds*

0

10

20

30

40

50

60

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

$ Billions

Source: Investment Company Institute (ICI)*includes net new cash flow


Main Models for a Global Mutual Fund Business

• Mutual recognition– Fund organized in one country may be

distributed in multiple countries without the need to re-register in each one

– Currently difficult to achieve as most countries are reluctant to relinquish control over regulating financial services

– Most countries instead practice “national treatment”


Main Models for a Global Mutual Fund Business (cont.)

• Master-feeder fund– Multiple feeder funds, each designed to

meet needs of the local market, invest in one master fund (often organized offshore)

– Such funds are legally and administratively complex

– Such funds may be prohibited in certain circumstances


Main Models for a Global Mutual Fund Business (cont.)

• Cloning– Multiple funds with almost identical investment

policies are managed in parallel so as to have virtually identical investment portfolios

– Difficult to take advantage of economies of scale

– Some “clones” may require separate, time-consuming treatment by the manager

– Some management companies may instead use “templating”


EU: European Union

• Positive trends

– UCITS (an EU directive) spells out one of the most advanced mutual recognition systems in the world

– Many countries are pursuing pension reforms, including privatized DC plans


EU: European Union (cont.)

• How mutual recognition system works– To sell a fund, U.S. fund sponsor must incorporate

a new fund in an EU jurisdiction and follow EU rules

– To sell an EU fund, after registered in one qualifying EU country, the fund can be offered for sale in other countries by filing a simple notice

– Host EU country must impose certain minimum conditions

• Modest compared to U.S. Investment Company Actof 1940

• Host country has considerable discretion


EU: European Union (cont.)

• Challenges– Automatic registration does not cover local

marketing• Funds must comply with marketing rules of each

jurisdiction, which may be used to undermine usefulness of the UCITS

– EU country of fund sale also retains jurisdiction over “other” areas

– Each country still has its own unique set of tax laws and market practices


Japan

• Positive trends– Aging population is producing an urgent need to reform the

pension system– Country has a large middle class and one of the highest

world savings rates– Government has begun to lift restrictions on foreign

competition in the financial services industry

• Challenges– Government’s progress on pension reform has been limited– Economy has been stagnant and distrust of broker-dealers

and other investment managers remains– Regulatory practices may still impose restrictions


Southeast Asia

• Positive trends– Some countries have taken steps toward economic and

financial reform that may create growth opportunities for mutual funds

• Challenges– Many countries are still emerging from the Asian financial

crisis of the late 1990s and the middle class has been diminished

– Some Asian countries require a foreign company to have a local partner in order to enter the mutual fund business

– Other Asian countries have relatively high capital and staff requirements for start-up fund business

– Must consider expense of building own distribution system versus utilizing established network of local distributors


North and South America

• Latin America– Positive trend: long-term opportunities are quite

good, due to• Overall wealth in population• Pension reform movements

– Challenges: near-term opportunities for fund managers are limited

• Wealth is concentrated in a handful of a few, who may not be interested

• Regulations are often hostile to foreign entrants to local market


North and South America (cont.)

• Canada– Positive trends

• Strong mutual fund marketplace exists• Well-developed equity culture• Increase in popularity of retirement savings accounts• Relatively open regulatory attitude toward foreign

entrants to local market

– Challenges• Retirement savings plans are limitations on investments

outside Canada• Growth of DC business in Canada has been slower than

expected


NAFTA: North American Free Trade Agreement

• Effective cloning mechanism available, but no cross-border sales within North America

• National treatment: foreign mutual fund is treated the same as a local mutual fund– All Mexican funds must invest in Mexican securities– Banks may advise, but not underwrite or sponsor, U.S.

mutual funds

• Reciprocity: foreign country applies rules of home country– Mexican mutual funds, sponsored by U.S. firms,

invest in all securities (like all mutual funds in U.S.)– Canadian banks may advise, underwrite, and sponsor

U.S. mutual funds (like all banks in Canada)


Case: Costs of Modifying Colossus and CanHolder

$ 550,000 Conversion to minis

100,000 Foreign content rebalancing

100,000 KYC Modifying Colossus

$ 750,000 Total

$ -0- Conversion to minis

-0- Foreign content rebalancing

200,000 First year’s manual KYC

200,000 Second year’s manual KYC

150,000 Automation of KYC

Modifying CanHolder

$ 550,000 Total


Case Q3: PossibleFund Classifications

Fund Type Fund Class Equity Rating

Bond fund Bond 0%

Stock fund Stock 100%

Asset allocation fund Stock 70%

Money fund Short-term 0%


Case Q3: PossibleProfile Inputs

Category Possible Choices Net worth Under

$50,000 $50,000–$100,000

Over $100,000

Investor knowledge None Limited Good Excellent

Time horizon until retirement

10 years 20 years 30 years 40 years

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