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International Investing AN INDEPENDENT ADVISOR’S GUIDE Our partner in developing this guidebook:

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International InvestingAn Independent AdvIsor’s GuIde

our partner in developing this guidebook:

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 3

Contents

executive summary ..................................................................................................................................................5

understanding International opportunities .......................................................................................................6Investment returns—united states versus International ................................................................................................................ 6

Case studies in International Investing ................................................................................................................................................. 8

diversification opportunities ................................................................................................................................................................. 10

Instrument diversification opportunities ............................................................................................................................................12

returns and Correlations in International diversification ...............................................................................................................14

developed and emerging Markets—trends and opportunities ....................................................................................................16

Accessing International opportunities ............................................................................................................ 20Indirect Investment ....................................................................................................................................................................................21

depository receipts..................................................................................................................................................................................28

direct Investment ......................................................................................................................................................................................29

Getting started ....................................................................................................................................................... 34risks related to International Investing .............................................................................................................................................34

leveraging pershing for direct Investment ........................................................................................................................................35

Appendices ...............................................................................................................................................................37MsCI Market definitions ........................................................................................................................................................................ 37

Methodology .............................................................................................................................................................................................. 37

About the Authors .................................................................................................................................................40

4 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

table of exhibitsexhibit 1: real returns of equities and Bonds Internationally 1900–2007

exhibit 2: Annual total returns (%) for u.s. large Company, International and european stocks

exhibit 3: Comparison of returns In equities and Bonds Across different regions, 2003–2009

exhibit 4: risks and returns of u.s. and Global portfolios

exhibit 5: HMC Asset Allocation 2009

exhibit 6: Calpers Actual Asset Allocation 2009

exhibit 7: number of Countries with stock exchanges

exhibit 8: MsCI Country Categorization Framework

exhibit 9: establishment of exchanges over time

exhibit 10: percentage of Financial Assets Within MsCI Category

exhibit 11: Amount of Financial Assets Within MsCI Category

exhibit 12: percentage of Market Capitalization by GICs sector

exhibit 13: Factors driving risk and return

exhibit 14: rolling 36-Month Correlation Between united states and developed Markets, emerging Markets

exhibit 15: BrIC Index versus G7 Index Monthly performance returns

exhibit 16: Contribution to Global Gdp Growth, ppp Basis

exhibit 17: emerging Markets with the Most significant Moves in 2008 and 2009

exhibit 18: economic Forecasts diverge over the next two Years

exhibit 19: real Gdp Growth BrIC versus united states

exhibit 20: projected real Gdp Growth BrIC versus united states 2006–2015

exhibit 21: population and Wealth Comparison

exhibit 22: Growth in purchases in Foreign securities by u.s. Investors

exhibit 23: number of International Fund and etF launches per Year

exhibit 24: distribution of pooled Funds by type

exhibit 25: distribution of AuM by type of International Index Mutual Fund

exhibit 26: distribution of AuM by etF type

exhibit 27: Growth in International Investing through etFs

exhibit 28: distribution of AuM by type of Actively Managed Mutual Funds

exhibit 29: summary Assessment of International etF and Mutual Fund options

exhibit 30: Fees on pooled Funds by region

exhibit 31: depositary receipts by Country Classification

exhibit 32: Growth in Annual depository receipts trading volume

exhibit 33: developed Countries direct Investment

exhibit 34: BrIC Countries direct Investment

exhibit 35: non-BrIC emerging Countries stock exchanges

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 5

executive summaryMany investors today are considering the opportunities available to them through international investing products. Globally, major institutional investors have always allocated a percentage of assets to non-domestic instruments as a means to increase portfolio diversification, decrease risk and improve overall investment performance.

In the United States, some of the most successful institutional investors have recently lowered the proportion of U.S. equities in their overall portfolios while growing their investments in developed and emerging markets. As well as investing in various geographical regions, these investors have also enhanced diversification by investing in instruments other than equities, including expanded opportunities across different industry sectors. Recent research from the International Monetary Fund (IMF) and others demonstrates the significant growth potential in the years ahead in the emerging markets of Brazil, Russia, India and China versus the developed economies of the United States, Europe and Japan.

Traditionally, larger institutional investors have utilized a direct investment approach in international investing by buying and selling shares on local stock exchanges. For smaller institutional investors, indirect investing via pooled vehicles such as mutual funds and exchange-traded funds (ETFs) has traditionally been a more economical approach. ETFs have become an increasingly popular way to gain exposure to these markets; ETFs based on international indices have been some of the most popular products in recent years. However, these products focus primarily on the large-cap equities of international markets, and therefore can provide only limited portfolio diversification opportunities.

A direct investment approach via the purchase of tradable instruments on local stock exchanges allows for more flexibility in an investment portfolio and can also provide access to a wider range of international instruments such as international bonds. This approach provides the ability to control underlying securities, which an ETF or mutual fund strategy does not, and mitigates the management and maintenance fees associated with these indirect investment vehicles.

Another vehicle for investors to consider is the depositary receipt, which gives investors the option of investing directly in the shares of a limited number of foreign companies (as opposed to using a pooled fund) in U.S. dollars and using U.S. standard settlement processes.

While international investing carries currency, liquidity, political and other unique risks, partnering with a service provider can facilitate the mitigation of these complicating factors. The right service provider can offer a complete range of trading facilities and operational support, with access to assets across multiple investment markets and features such as multicurrency support and reporting. Beyond operational infrastructure, firms can leverage a service provider’s local market knowledge and expertise on legal and risk management issues, thereby increasing investor confidence.

6 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

understanding International opportunitiesMajor institutional investors have long invested in international markets with the expectation that those assets will increase diversification in their portfolios, reduce overall risk and improve investment returns. Diversifying into different geographical regions and instruments has typically enabled these investors to see better investment performance than if they had remained solely invested in U.S. assets.

Investment returns—united states versus International

Various studies through the years have compared investment returns in the United States versus international markets. For example, in 2006, the London Business School completed a study of investment performance across 17 major markets, for which data was available going back to 1900. Its findings show that the United States ranked fourth in terms of market returns. The best performers in terms of equities were Australia and Sweden, both of which had an annualized percentage real return of 7.6% compared with a global average of 5.7%. Exhibit 1 below shows the findings of an updated joint study between ABN AMRO and the London Business School, which found that the United States had annualized returns of 6.5% for equities and 1.9% for bonds, whereas Australia and Sweden still held strong at 7.9% and 7.8%, respectively, in the equity market.

Exhibit 1: Real Returns of Equities and Bonds Internationally 1900–2007

BelgiumItaly

GermanyFrance

NorwaySpainJapan

SwitzerlandIreland

DenmarkNetherlands

United KingdomCanada

United StatesSouth Africa

SwedenAustralia

0 2 4 6 8-2

Source: ABN AMRO/LBS Global Investment Returns Yearbook 2008

Equities Bonds

A 2008 study from Ibbotson Associates provides a similar story: $1 invested in 1969 in international stocks was worth $64.03 in 2007; for U.S. stocks, the same $1 was worth $54.05. Exhibit 2 shows the annual total returns of U.S. large company stocks compared to international stocks and European stocks from 1970 to 2007. Investment returns for U.S. stocks have lagged behind international and European stock performance since 2002.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 7

Exhibit 2: Annual Total Returns (%) for U.S. Large Company, International and European Stocks

Source: Ibbotson Stocks, Bonds, Bills, Inflation 2008 Classic Yearbook

U.S. Large Company stocks International stocks European stocks

100

80

60

40

20

0

-20

-40

1970 20071974 1982 1998199019861978 20021994

Another element of the international equation is that performance can be substantially enhanced through the inclusion of other international instruments, which can help to increase returns and lower risk.

Exhibit 3 shows a comparison of returns in equities and bonds in a subset of key markets. The Sharpe ratio has been added, which measures the return received on the instrument versus the risk taken (as measured by the volatility of the instrument’s returns). The higher the Sharpe ratio, the better the returns are for each unit of risk. As can be seen in Exhibit 3, returns across asset classes have been lowest in the United States and higher in both the other developed economies and the emerging markets. In terms of the Sharpe ratio, bonds have performed better than equities in the last five years across all markets.

Exhibit 3: Comparison of Returns in Equities and Bonds Across Di�erent Regions, 2003–2009

Source: Capco analysis (please see Appendices for methodology and calculations)

Equities Bonds Sharpe ratio

All World United States EmergingMarkets

World (excludingUnited States)

4.5%

6.4%

1.2%

5.2%

7.7%8.5%

15.8%

9.5%

0.24 0.951.2

0.38 0.73 0.73 0.930.06

8 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Constructing sample world portfolios illustrates this more clearly. Exhibit 4 shows two portfolios: P1, which represents U.S.-only equity and fixed income and P2, which represents a global portfolio with both U.S. and international equity and international fixed income.

Exhibit 4: Risks and Returns of U.S. and Global PortfoliosComparison of risk and return profile of a U.S. balanced

portfolio with a portfolio composed of U.S. and emerging markets

Source: Capco analysis (please see Appendices for methodology and calculations)

Risk (annualized standard deviation usingmonthly returns) October 2003 – September 2009

Retu

rn (a

nnua

lized

com

poun

ded

retu

rn u

sing

mon

thly

retu

rns)

Oct

ober

200

3 –

Sept

embe

r 200

9

P2

8%

6%

4%

2%

0%

7% 8% 9%

United States and Emerging Markets (EM)

P1United States only

Portfolio Composition

P1 U.S. only portfolio:U.S. Equities 60%U.S. Bonds 40%

P2 U.S. and EM portfolio:U.S. Equities 48%U.S. Bonds 32%EM Equities 12%EM Bonds 8%

The sample illustrates that the U.S.-only portfolio, P1, has both lower returns, as well as higher risk than the global portfolio. Between the two portfolios, P2, which has an international mix of both equities and bonds, has a higher return with lower risk.

Case studies in International Investing

Some of the world’s leading institutional investors provide effective case studies for the benefits of international diversification. Investors such as Harvard Management Company (HMC) and California Public Employees’ Retirement System (CalPERS) achieved in fiscal year 2008 significant returns of 8.6% and -2.4%, respectively; these are particularly impressive returns given that stocks were down over 10% in the same period. HMC had a relatively low investment in domestic equities and CalPERS showed a high percentage in international equities.

HMC is an investment management company responsible for managing the $26 billion endowment of Harvard University. In fiscal year 2009, HMC increased its asset allocation in emerging market equity from 10% to 11%. Developed foreign market equity remained relatively stable, comprising 11% of the asset allocation, further indicating its commitment and confidence in investing internationally. In fiscal year 2008, emerging markets (7.6%) outperformed the benchmark (4.8%), while foreign bonds (21.3%) also outperformed the benchmark (18.5%).

For fiscal year 2009, the endowment experienced a -27.3% rate of return; the annualized five-, ten-, and twenty-year performances have outperformed the benchmark, demonstrating that the recent year is a performance anomaly. HMC reports that the five-year annualized return is 6.2%, and the twenty-year annualized return is nearly twice as strong at 11.7%, further showing that performance has been positive during the long term.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 9

Cash3%

Absolute Return18%

Real Assets26%

Fixed Income13%

Private Equity13%

Emerging MarketsEquity 11%

Developed ForeignMarkets Equity

11%

Domestic Equity11%

Exhibit 5: HMC Asset Allocation 2009

Source: Harvard Management Company

CalPERS is the largest defined benefits pension plan in the United States, with $180.9 billion in assets under management as of June 30, 2009. Although its asset value declined by 23.4% in the last year, CalPERS continues to show a strong long-run twenty-year performance, with a positive return of 7.75%.

The June 2009 target asset allocation of foreign equity of 24.5% was consistent with that of the previous year, a further indication of confidence in the international markets. As shown in Exhibit 6, the actual allocation in international equity exceeds the targeted percentage. Moreover, CalPERS raised its alternative investment target in anticipation that the private equity market will bring about higher future returns.

Exhibit 6: CalPERS Actual Asset Allocation 2009

Source: CalPERS July 31, 2009

Inflation Linked3%Real Estate

9%

Private Equity11%

International Equity26% Domestic Equity

26%

Global Fixed Income24%

Cash1%

The above examples from HMC and CalPERS demonstrate that international diversification has been a key component driving institutional investors’ investment returns. Importantly, this has included diversification into different geographical regions, instruments and sectors.

10 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

diversification opportunities

Geographic diversification

Political changes in the past twenty years have dramatically increased the number of countries available for investment. Up until the fall of the Berlin Wall in 1989, the number of stock exchanges globally had remained constant for decades. After the Wall fell, that number grew dramatically, more than doubling in two decades.

A 2007 Capco study presented a top-down analysis of the growth in exchanges at the country level.1 The study used the International Standards Organization (ISO) list of 244 countries, of which the World Bank had population and economic statistics for 2009. The findings from the study showed that in 1988, stock exchanges existed in 63, or 26%, of the 244 countries. These countries comprised 58% of global population and 81% of global gross domestic product (GDP, measured on the purchasing power parity [PPP] basis).

By 2005, there were national or regional stock exchanges present in 145, or 59%, of ISO-listed countries, which together comprised 92% of the world’s population and 99% of global GDP (on a PPP basis). Another four countries were planning to add exchanges at the time of the study: Libya, Cambodia, Sierra Leone and Gibraltar.

Exhibit 7: Number of Countries With Stock Exchanges

Source: Capco Analysis 2007

Num

ber N

ew

160

140

120

100

80

60

40

20

0

15851792

1808

1850

1861

1869

187518

8118

9018

9419

121929

1953

1960

19691975

1981

1986

1990

199319

9619

992002

2005Cu

mul

ativ

e

Year

12

10

8

6

4

2

0

The remaining 95 ISO countries constitute only 1% of global GDP. There were 65 countries with population counts that ranged from approximately 20,000 in Palau to 73 million in Ethiopia. The bulk of these, approximately 50 countries, had populations under 10 million. The remaining 30 countries were small islands with limited or no population. In summary, the study concluded that institutional and legal frameworks and infrastructure for stock trading had been established in virtually all of the world’s significant economies at that point.

This is significant in terms of assessing these countries from an investment perspective as long-term potential growth opportunities. As the World Economic Forum states, “Stock market liquidity is statistically significant in terms of its positive impact on capital accumulation, productivity growth and current and future rates of economic growth. More generally, economic theory suggests that stock markets encourage long-run growth

1 See page 37 for Methodology.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 11

by promoting specialization, acquiring and disseminating information and mobilizing savings in a more efficient way to promote investment. Research also shows that as countries become richer, stock markets become more active and efficient relative to banks. Bond markets have received little empirical attention, but recent research has shown that bond market development does in fact affect economic output.” (World Economic Forum Financial Development Report, 2008).

With so many investment options available, institutional investors have relied on various global investment frameworks and performance benchmarks to select in which countries to invest, set asset allocation strategies and evaluate their relative performance. One of the most common sets of frameworks and benchmarks for global investing is the Morgan Stanley Capital International (MSCI, now MSCI Barra) index. MSCI has developed frameworks for categorization of global economies, as well as stock market indices for multiple countries and assets.

Exhibit 8: MSCI Country Categorization Framework

Economy Region Countries

developed Markets

north America – Canada – united states

europe

– Austria– Belgium– denmark– Finland– France– Germany

– Greece– Ireland– Italy– netherlands– norway– portugal

– spain– sweden– switzerland– united Kingdom

pacific – Australia– Hong Kong

– Japan– new Zealand

– singapore

emerging Markets

latin America – Argentina– Brazil

– Chile– Colombia

– Mexico– peru

europe, Middle east and Africa

– Czech republic– egypt– Hungary– Israel

– Jordan– Morocco– poland– russia

– south Africa– turkey

emerging Asia– China– India– Indonesia

– Korea– Malaysia– pakistan

– philippines– taiwan– thailand

Frontier Markets

Central and eastern europe and Commonwealth of Independent states

– Bulgaria– Croatia– estonia– Kazakhstan

– lithuania– romania– serbia– slovenia

– ukraine

Africa – Kenya– Mauritius

– nigeria– tunisia

Middle east– lebanon– Bahrain– Kuwait

– oman– Qatar– saudi Arabia

– united Arab emirates

Asia – sri lanka – vietnam

Source: Morgan Stanley Capital International Index

The MSCI framework used to differentiate the various investment markets available applies a set list of criteria to classify countries, primarily World Bank net income per capita, size and liquidity of corporate listings available, as well as market accessibility. (See Appendix 5.1 for details.) With this framework, MSCI has classified economies and their performance indices into three major tiers: Developed, Emerging and Frontier. The Developed Index series started in 1969, the Emerging Index in 1988, and the Frontier Index in 2007. The major indices in use today for benchmarking global investment performance are the World Indices

12 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

(all developed markets), EAFE (Europe, Australasia and the Far East, or the developed markets excluding the United States and Canada), Emerging Markets, the All-Country World Index (which is the combination of all the developed and emerging markets), and the frontier markets.

Combined, the countries in all three categories together represent only 68 of the 145 investable countries available. In terms of GDP and population, however, they represent 95% of global GDP and 80% of population, with the developed and emerging markets alone (48 countries) comprising the bulk of global economic activity: 92% of GDP and 73% of population.

Over time, it is likely that frontier and other less-developed countries with exchanges will contribute a larger percentage to global GDP as their economies grow and mature. When the Emerging Markets Indices were first launched in 1988, they comprised less than 1% of total global stock market capitalization; by 2007, they were 11% of this total.

The chart below shows the relative age of the exchanges, demonstrating that the majority of frontier and fledgling countries have only recently launched exchanges.2 As their economies grow and mature, these countries should begin to contribute more to global GDP growth, similar to the path taken by the emerging market countries.

Exhibit 9: Establishment of Exchanges Over Time

Source: Capco Analysis 2007

Num

ber o

f Exc

hang

es O

pene

d pe

r Yea

r

12

10

8

6

4

2

0

2007

Year

Developed Emerging Frontier Fledgling

17701792

1808

1850

1861

1869

187518

8118

9018

9419

121929

1953

1960

19691975

1981

1986

1990

199319

9619

992002

2005

Instrument diversification opportunities

As previously noted, diversifying across international instruments enhances investment performance by reducing risk and increasing returns. According to the World Federation of Exchanges, there were approximately more than 46,000 listed equities available globally and more than 140,000 listed bonds in 2008. On an over-the-counter basis, there are many more fixed income and derivative instruments available.

2 ‘Fledgling countries’ are countries with stock exchanges that are not officially part of the MSCI Frontier Index.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 13

In terms of the value of the assets available, total assets across the three MSCI segments were approximately $140 trillion in 2007.3 Equities were approximately $62 trillion and fixed income (public and private) was approximately $76 trillion.

The developed markets still represent the majority of global assets, at 83% of the total. They also have a balanced mix of equity, private debt and public debt available for investment.

Emerging markets are approximately 16% of total assets, and frontier markets represent 1% of total assets. In these sectors, equities are still the dominant vehicle, at approximately 70% and 78% of total investable assets, respectively; but there are fixed income opportunities in each of these sectors, as well.

Exhibit 10: Percentage of Financial Assets Within MSCI Category

Source: Financial Development Report 2009, World Economic Forum

Equity Securities Private Debt Secutities Public Debt Securities

Developed Markets Frontier MarketsEmerging Markets

100%

80%

60%

40%

20%

0%

Exhibit 11: Amount of Financial Assets Within MSCI Category ($ Billions)

Source: Financial Development Report 2009, World Economic Forum

Equity SecuritiesPrivate Debt SecutitiesPublic Debt Securities

Developed Markets Frontier Markets TotalEmerging Markets

$160,000

$140,000

$120,000

$100,000

$80,000

$60,000

$40,000

$20,000

$0

$45,616.80 $15,720.00 $1,215.50 $62,552.30 $46,274.70 $2,467.20 $102.50 48,844.40 $23,334.10 $4,161.90 $238.60 $27,734.60

3 Financial Development Report 2009, World Economic Forum. Not all countries represented in sample: Developed = 20/23; Emerging = 23/25; Frontier = 8/22.

14 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

sector diversification

Another element to consider is the amount of sector diversification available in developed and emerging markets. The Global Industry Classification Standard (GICS) categorizes companies into ten investment sectors. As the chart below shows, emerging markets have investable companies in all ten, but they are more weighted towards materials (commodities) and energy than are the developed markets, which reflects their economic growth patterns. For example, in emerging markets, energy and materials are 31% of total market capitalization versus 15.7% in developed markets. Conversely, the consumer and health segments are much more dominant in developed markets, 28.1% of total, than in emerging markets, where they represent only 11.5%. For investors focused on sector-based investment themes, expanding the opportunity set to include relevant companies in emerging markets should be considered.

Exhibit 12: Percentage of Market Capitalization by GICS Sector

Percentage of GICS Sector Total

Source: Emerging Markets: A 20-Year Perspective, MSCI 2008

Developed Emerging

Health

Utilities

Consumer Staples

Consumer Discretionary

Industrials

Telecommunication

Information Technology

Materials

Energy

Financials

9.0%1.6%

4.6%3.3%

8.4%4.8%

10.7%5.1%

10.2%8.4%

4.7%9.7%10.1%

13.2%6.2%

14.3%9.5%

16.7%26.8%

22.8%

returns and Correlations in International diversification

What drives returns in International Investing?

The preceding sections outline diversification opportunities across geographical regions, instruments and sectors or industries. A fourth variable, style (value, growth, etc.), is also relevant depending on the investment strategy. For investors, an important question must be what component of this diversification drives the risk and return from the investment. A study undertaken by MSCI Barra decomposed the drivers of risk and return into three fundamental criteria: country factors (risk and return due to local conditions, including currency), industry and sector factors (risk and return of a company belonging to a particular industrial segment) and style factors (risk and return of a company belonging to a particular style). MSCI’s analysis showed that for the developing countries, represented here by EAFE, risk and return was almost equally due to country and industry factors, and less so for style. For the emerging markets, the majority of risk and return was due to country factors.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 15

Developed Markets (EAFE)

Source: The World Is Not Enough?, MSCI Barra Research, July 2008

Style Share of Global Component

Country Share of Global Component Industry Share of Global Component

Exhibit 13: Factors Driving Risk and Return

100%

80%

60%

40%

20%

0%

Feb 99 Apr 07Feb 01 Apr 05Mar 03

Cro

ss-S

ectio

nal V

olat

ility

12-M

onth

Mov

ing

Ave

rage

Emerging Markets

Source: The World Is Not Enough?, MSCI Barra Research, July 2008

Style Share of Global Component

Country Share of Global Component Industry Share of Global Component

100%

80%

60%

40%

20%

0%

Feb 99 Apr 07Feb 01 Apr 05Mar 03

Cros

s-Se

ctio

nal V

olat

ility

12-M

onth

Mov

ing

Ave

rage

the diversification Benefits of Correlation

One of the primary benefits of international diversification is to enable investors to invest in assets whose risk and return profiles are driven by different factors—as one asset drops, another may be rising. However, the correlation of assets in different countries has been increasing in recent years, meaning that diversifying internationally appears to have decreased the opportunity for non-correlated returns.

16 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Exhibit 14: Rolling 36-Month Correlation Between United States and Developed Markets, Emerging Markets

Source: The World Is Not Enough?, MSCI Barra Research, July 2008

DM-EMUSA-EAFE USA-EM

100%

80%

60%

40%

20%

0%

Dec 90Dec 91

Dec 07

Dec 93

Dec 94

Dec 95

Dec 96

Dec 97

Dec 98

Dec 99

Dec 00

Dec 02

Dec 03

Dec 04

Dec 05

Dec 06

Dec 01

However, as Exhibit 14 above shows, correlation between markets has not always been a straight-line phenomenon, but instead is cyclical and marked by ups and downs. Taking the USA–Emerging Market (USA-EM) series as an example (orange line in Exhibit 14 above), the correlation between the two peaked in 1993 at approximately 65%; two years later, correlation had been approximately halved to 30%. Similarly, in 2004, correlation for the series was approximately 80%; three years later it had dropped to approximately 60%.

As expected, the overall trend for the past decade has been up on an absolute basis; however, on a relative basis, there are still periods of decreasing correlation, which have benefited investors with internationally diversified portfolios. As long as there is a relative difference in the performance of U.S. and non-U.S. markets, (correlation remaining below 100%), the benefits of diversification will still exist.

developed and emerging Markets—trends and opportunities

From 2003 to 2007, the global economy boomed for a sustained period. Global GDP rose at an average of approximately 5% a year, its highest sustained rate since the early 1970s. About three quarters of this growth was attributable to a broad-based surge in the emerging and developed economies.4 Events since the summer of 2007 and through 2009 have significantly altered the global economic and investing landscape.

The economic crisis has had a significant impact on the global economy, especially in the emerging markets that suffered a sharp reduction or redemption in capital flows because of the desire for capital protection. Despite a 39% fall in the MSCI Emerging Markets Index, the emerging markets have grown by 93% (Compound Annual Growth Rate [CAGR]) starting from 2003, as compared to the S&P 500®, which has grown by only 6.5%. Thus, although the credit crisis and the subsequent events of 2008 have caused short-term volatility and declines in emerging markets, long-term attractiveness remains.

4 World Economic Outlook, International Monetary Fund, October 2008.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 17

Exhibit 15 compares monthly index performance returns for Brazil, Russia, India and China (BRIC) and G7 indices on a basis points measurement. The graph indicates that the emerging markets BRIC countries rebounded faster than the G7 countries since January 2009, which further shows that BRIC have been quick to recover from the downturn compared to the developed nations. During September 30, 2009, the BRIC Index returned 2.55%, which was more than double that of the G7 Index, which had a 1.02% return. Even during the lowest monthly return in February 2009, the BRIC Index had nearly double the returns of the G7 nations at 1.37% and 0.70%, respectively. The single-year annualized return, as of September 30, 2009, for the BRIC Index was 18.85%, while the G7 Index showed a -6.83% annualized return for the last year.

Exhibit 15: BRIC Index Versus G7 Index Monthly Performance Returns

Source: MSCI.com Index Performance, October 2009

BRIC

G7

400

300

200

100

60

Sep 04 Sep 09Sep 06 Sep 08Sep 07Sep 05

Basi

s Po

ints

In the years ahead, global growth will depend more on the emerging markets than the developed markets. Exhibit 16 shows that the United States has seen its share of global GDP slowly decrease from 1995 to 2009, while emerging countries, such as China, continue to grow.

Exhibit 16: Contribution to Global GDP Growth, PPP Basis

Source: IMF

USA Other Advanced Economies China Rest of the World

1970-74 1975-79 1980-84 1985-89 1990-94 1995-99 2000-04 2005-09

100%

80%

60%

40%

20%

0%

Cont

ribut

ion

Perc

enta

ge

18 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Key emerging economies

The BRICs

Of the emerging markets, the global focus has been on Brazil, Russia, India and China, also known as the BRIC economies. This was a phrase coined by Goldman Sachs in 2002 to refer to the nations that it highlighted as most likely to become forces in the global economy. A combination of a large population, a shift to a more capitalist orientation and access to natural resources has fostered the rapid growth in BRIC countries, making them economically attractive and thus an area of high attention. There remain other countries that are exhibiting rapid growth, such as Poland, South Africa and Oman, though they do not yet currently possess the combination of factors described above. Most of the BRIC countries have rebounded rapidly during the start of 2009.

80%60%40%20%

0%-20%-40%-60%-80%

-100%

Cont

ribut

ion

Perc

enta

ge

Exhibit 17: Emerging Markets With the Most Significant Moves in 2008 and 2009

Russia India Turkey Hungary Brazil Russia Chile Indonesia Brazil India

Countries with BiggestDeclines in 2008

Countries with StrongestRecoveries in the First

Half of 2009

Source: An Update on Emerging Markets, MSCI Barra Research, September 2009

Exhibit 18: Economic Forecasts Diverge Over the Next Two Years

Source: IMF Forecasts (2008) for 2009-1010

8%6%4%2%0%

-2%-4%-6%

Fore

cast

GD

P G

row

th(A

vera

ge 2

009-

1010

Cha

nge)

Brazil China India Russia France Germany Hong Kong Singapore U.K. U.S.

Moreover, BRIC countries are shown to have stronger and more positive GDP growth predictions than some developed countries. By 2040, the BRIC countries are forecasted to overtake the G7 nations in terms of GDP. As these economies grow, domestic wealth is created at a fast pace. For example, over the next ten years the growth in the middle classes of these countries is expected to be 400%. Within the next five years, there will be more high-net-worth individuals in China and India than in the United Kingdom. By 2025, Russia is expected to have a higher GDP per capita than the United Kingdom.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 19

Exhibit 19: Real GDP Growth BRIC Versus United States

Source: IMF, October 2009

15%12%9%6%3%0%

-3%-6%-9%

-12%-15%

199319

941995

1996

1997

1998

1999

20002001

20022003

20042005

20062008

2007

Perc

enta

ge o

f Gro

wth

China India Russia Brazil United States

As demonstrated in Exhibit 19, the rate of GDP growth in the United States has decreased or remained relatively stable, whereas the rate of GDP growth by BRIC countries has shown a higher increase year over year.

Exhibit 20 illustrates the projected real GDP growth rate from 2015 to 2020 for BRIC countries compared to the United States. The BRIC average growth rate is 4.6%, which is more than double the projected U.S. growth rate over five years.

Exhibit 20: Projected Real GDP Growth BRIC Versus United States 2015-2020

Source: IMF

India China Brazil Russia U.S.

6%

5%

4%

3%

2%

1%

0%Ave

rage

Per

cent

age

Year

ove

r Yea

r

BRIC Average 4.6%

U.S. 2.1%

20 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Even with growth in the BRIC countries, it is likely that the United States will remain the dominant economy for the foreseeable future. The population base of the United States is only third in size behind China and India, and its economy and financial markets remain the largest in the world. However, India and China specifically have demonstrated consistent high growth in GDP and in GDP per capita. China will likely become the second largest economy by 2020.

Exhibit 21: Population and Wealth Comparison

Source: IMF October 2009

Emerging MarketsDeveloped Markets Frontier Markets

2009 Population (Million)

Size of Bubble Represents GDP (Measured in USD with Current Exchange Rate 2009)

Russia

Brazil

Germany

UnitedStates

Japan

India

China

140012001000800600400200-200 0

25%

20%

15%

10%

5%

0%

-5%

Argentina

U.K.

GD

P G

row

th R

ate

Accessing International opportunitiesNon-institutional investors now have an increasing range of investment options in international markets, enabling them to capitalize on opportunities historically limited to institutional investors. The two main approaches can be categorized at a high level as direct and indirect investing.

Indirect investing via pooled funds, including mutual funds, and ETFs allows investors to gain exposure primarily to the equity capital markets of developed and emerging markets. Direct investing into international markets includes investing in tradable instruments on local stock exchanges or over the counter through a broker-dealer.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 21

U.S. investor demand for foreign stocks and bonds has increased during the past several years, and pooled funds have been one of the primary means for investing abroad because they provide an economical way of accessing these markets. In 2007, U.S. residents purchased $252 billion in foreign stocks and bonds, and mutual funds and ETFs accounted for most of those purchases (Exhibit 22).

Exhibit 22: Growth in Purchases in Foreign Securities by United States Investors

Source: Fact Book 2008, Investment Company Institute

Mutual Funds ETFs Non-Fund

2003 2004 2005 2006 2007

200

150

100

50

0

Billi

ons

($)

Indirect Investment

pooled Funds

Mutual funds fall into two major categories: index and active. Index mutual funds are typically constructed to simply mirror an investment index such as the S&P 500 or MSCI EAFE. These are usually referred to as passive investment vehicles as the underlying stocks in the portfolio are only changed when there are changes to the underlying constituent stocks in the index. Actively managed mutual funds are funds that are actively traded according to the investment strategy of the portfolio manager, and stocks in the portfolio are actively traded as needed to meet investment objectives.

ETFs are similar to index mutual funds in that they are constructed to mirror indices, but they are listed on stock exchanges and so are tradable intraday, as opposed to mutual funds, which are only bought and sold at end-of-day prices.

22 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Exhibit 23 demonstrates the overall growth of international pooled funds in the U.S. in terms of the number of launches of actively managed funds, index funds and ETFs. After a lull in the growth rate during the 1990s, 2005 saw a significant increase in the number of new fund launches, catering to an increasing appetite for international investment.

Exhibit 23: Number of International Fund and ETF Launches per Year

Source: Morningstar Research

Active Index ETF

150

120

90

60

30

0

Num

ber o

f Lau

nche

s

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2008

2007

1953

1954

1956

1962

1959

1970

1973

1974

1976

1978

1979

1980

1981

1982

1984

1985

1986

1987

1988

1989

1990

1001

1992

1983

Among the three types of international funds, active funds (managed by portfolio managers based on views of anticipated favorable business conditions in an industry or interest rate movements affecting a specific asset class) are the largest, with total assets under management (AUM) of approximately $974 billion. ETFs are approximately $200 billion and index funds are approximately $118 billion. In terms of the numbers of funds, there are approximately 829 actively managed funds, 153 ETFs and 56 index funds.

Exhibit 24: Distribution of Pooled Funds by Type

Source: Morningstar Research

Number and Percentage of Funds by Fund Type(Total = 1038)

AUM and AUM Percentage of Funds by Fund Type(Total = $1.3 trillion)

Index 56, 5%

ETF 153, 15%

Active 829, 75%

Index $118 billion, 10%billion

ETF $200 billion, 15%

Active $974 billion, 75%

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 23

Index Mutual Funds

Currently, index funds represent the smallest international opportunity set; only approximately 42 funds with less than $100 billion in AUM are available for investment.5 As the chart below shows, 76% of the funds are focused on developed markets, primarily international large-cap stocks. Offerings for emerging markets funds exist, but a review of the underlying holdings shows that they have more than 25% of their assets in non-emerging markets, and so they represent a blend of developed and emerging assets.

Developed $89.5 billion, 76%

Exhibit 25: Distribution of AUM by Type of International Index Mutual FundAUM and Percentage of Index Funds by Fund Type

(Total = $118 Billion)

Source: Morningstar Research

Developed/Emerging Blend $1.4 billion, 1%

Global $26.8 billion, 23%

Expense ratios for these funds range from 3 to 300 basis points, with an average of approximately 84 basis points. Fees for the top ten funds, however, range from 3 to 112 basis points, with an average of 29 basis points.

ETFs

ETFs were initially developed as an alternative to index mutual funds, which investors can only buy and sell once per day after the underlying assets have been priced at the end of the trading session. Similar to index mutual funds, ETFs typically track a stock index, but are listed on exchanges, and so they can be traded on an intra-day basis like a stock.

Since their inception, the market for ETFs has grown tremendously. ETFs provide investors with the flexibility to make more precise asset allocation decisions than index funds, typically with lower expense ratios.

5 Source: Morningstar Research. See Appendix for a detailed description of the fund categorizatoin methodology for this section.

24 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Currently, there are over 150 funds with total AUM of approximately $200 billion (Exhibit 26). ETFs are available for specific country and regional indices in both the developed and emerging sectors, giving an investor the ability to pursue a global strategy in a number of different markets.

Developed $89.5 billion, 45%

Exhibit 26: Distribution of AUM by ETF TypeAUM and Percentage of ETF Funds by Fund Type

(Total = $200 Billion)

Source: Morningstar Research

Developed/Emerging Blend $19.5 billion, 10%Global $3.8 billion, 2%

Emerging $86.6 billion, 43%

In 2008, the slower growth of ETF assets reflected the overall market movement, but there is still evidence for future growth according to the overall trend in Exhibit 27. Although the ETF net asset share of international ETFs grew only at a rate of 22% in 2008, these shares have increased from 3% to 30% between 2000 and 2007, supporting the view that investors are looking more favorably upon diversifying their portfolios through indirect investments in the international markets via ETFs.

Whereas many other investment vehicles, such as hedge funds and mutual funds, faced net outflows in 2008, ETFs grew at a steady rate with a net inflow of approximately $177 billion. Investor interest in global and international ETFs continues to remain strong and, according to the Investment Company Institute (ICI), between 2004 and 2008, international and global ETFs issued approximately $142 billion net in new shares.

Expense ratios for developed ETFs range from 23 to 108 basis points; for emerging ETFs, from 16 to 98 basis points. The overall average is around 57 basis points.

Expense ratios for the top ten developed ETFs range from 11 to 52 basis points, and for the top ten emerging ETFs, from 20 to 72 basis points.

Exhibit 27: Growth in International Investing Through ETFs

Source: Investment Company Institute

% Other ETF % Global/International ETF

Years

100%

80%

60%

40%

20%

0%

1996 200820072006200520042003200220012000199919981997

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 25

Actively Managed Mutual Funds

Actively managed funds have the longest track record in international investing, with the first fund launched in 1953 by DWS, followed by Templeton in 1954. Currently, there are approximately 829 funds with approximately $974 billion in AUM.

Exhibit 28: Distribution of AUM by Type of Actively Managed Mutual FundsAUM and Percentage of Active Funds by Fund Style

(Total = $974 Billion)

Source: Morningstar Research

Developed $510.4 billion, 52%

Developed/Emerging Blend $286.6 billion, 29%Global $158.9 billion, 16%

Emerging $17.8 billion, 2%

In terms of the breadth of choice, funds in developed markets offer a much wider range based on regions, countries, styles (value versus growth) and industry sectors. While many are labeled “emerging,” a review of their underlying holdings indicates a blend of developed and emerging assets.

For actively managed international funds, the expense ratio had a relatively broad range, from 18 basis points to over 330 basis points, with an average of 133. Indeed, expense ratios for the top ten funds range from 47 to 128 basis points, highlighting the need for an investor to carefully balance any perceived potential upside with associated costs.

summary

Both international ETF and international mutual fund instruments can provide the required exposure to take advantage of potential growth and diversification opportunities, though there are factors relevant to each instrument that should be considered. Exhibit 29 highlights the key attributes of both ETFs and mutual funds as they pertain to investment costs and investor control, as well as showing which investor profiles might be best suited to each strategy.

26 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Exhibit 29: Summary Assessment of International ETF and Mutual Fund Options

Investment Option Fees Customization Control Recommended Investor Profile

International ETFs – lower fees as etFs are traded as stock

– More tax effective since etFs do not constantly buy and sell shares and capital gains tax is minimized

– no back-end fees or penalties incurred on redemptions

– no control of underlying stock or bond portfolio

– variety of international etFs, including broad-based and regional etFs, single-country, developed markets, emerging markets and global sector etFs

– no rebalancing option

– no active management

– shorter investment horizon

– Interest in short-term trading

– desire for higher liquidity

– desire for greater diversification and potentially higher returns

– low interest in following the markets and managing portfolios

– Infrequent trading, whereas frequent trading may result in high transaction costs and tax liability

– smaller initial investments, and no minimum investments on most etFs

– taxable accounts benefit from tax advantages of etFs

– More complex trading techniques for savvy investors, such as short sales and stop loss and limit orders

International Mutual Funds

– relatively higher fees, for example load fees

– Foreign taxes

– sales charges, annual fees and other expenses

– Wide choice of mutual fund types, including international, regional, country and global sector funds

– limited ability to weight industry segments

– dollar cost averaging possible

– Automatic dividend reinvestment possible

– no control over capital gains tax

– no control over dividend cycles

– longer investment horizon

– desire for more active management of funds

– desire for greater diversification and potentially higher returns

– desire to regularly invest small amounts and lower trading costs involved

– smaller investors with limited funds seeking to avoid commission fees

– More frequent traders and fewer transaction fees assessed

Costs

ETFs are generally less expensive than index and actively managed mutual funds, particularly in international investments. Unlike mutual funds, they also do not require a minimum investment. However, investing in markets that are potentially more volatile has been more problematic for ETFs than active mutual funds, as they do not have the ability to select and rebalance investments in times of crisis.

Actively managed mutual funds have the highest expense ratios due to the additional costs incurred in evaluating overseas companies. Mutual funds typically charge front-end or back-end loads on top of the management fees. Some international mutual funds also impose a two-month redemption fee on sales in an attempt to reduce short-term arbitrage trading, which might seek to take advantage of time zone differentials in opening and closing price levels. Tax-managed funds also may impose redemption fees as a means of discouraging shareholder turnover. Typically, however, back-end fees or penalties are not assessed on redemptions in ETFs.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 27

Exhibit 30: Fees on Pooled Funds by RegionFees for International Pooled Funds—Lows and Highs by Fund Style

Source: Morningstar Research

Active ETF Index

Developing/EmergingHighLow HighLow

DevelopedHighLow

GlobalHighLow

Emerging

Basi

s Pp

oint

s

0

50

100

150

200

250

300

350

Flexibility

ETFs provide investors the opportunity to exploit daily short-term movements in the market by allowing intraday trading, and to take advantage of newly established trends. Investors in mutual funds are restricted to trading once a day. One benefit that mutual funds seem to have over ETFs is the flexibility of dollar cost averaging. It might be more costly to trade frequently in ETFs, as a commission is charged for each transaction.

ETFs and mutual funds can also differ in the treatment of dividends. While mutual funds give investors the flexibility to automatically reinvest dividends, investors in ETFs must explicitly control how dividends are handled. A decision to reinvest dividends may result in transaction fees, though some brokers allow reinvestment of dividends at no additional cost. In addition, some older ETFs are structured as unit investment trusts (UITs). The delay in reinvesting dividends in UITs can have a negative effect on total returns. In UITs, dividends are held in an interest-bearing account until the end of each quarter before being reinvested. In contrast, a mutual fund may reinvest dividends daily.

risks

Unlike mutual funds, ETFs are traded on stock exchanges. The intraday pricing characteristic of ETFs results in transactions that are priced at market value, rather than end-of-day net asset value (NAV). This can work in favor of the investor when the ETF is bought at a discount to the underlying securities, but may adversely impact the investor when bought at a premium. In thinly traded, volatile markets, the bid or ask spread of an ETF may widen, which may result in investors buying at a premium to the portfolio’s value, or conversely, selling at a discount. Transactions in mutual funds, however, are priced once a day at the fund’s closing price, which prevents investors from taking advantage of intraday price movements.

28 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

The positions held by ETFs are more transparent as they always align with major indices. This makes asset allocation across an investor’s entire portfolio easier to achieve as all the underlying instruments are known. A mutual fund might only release its holdings on a quarterly basis or less frequently, making it difficult to ascertain the underlying securities and the exposure to each. Unlike actively managed mutual funds, ETFs that track a particular underlying market segment may allow investors to execute a strategy more effectively as these investment vehicles remain true to their stated objectives.

depository receipts

Investors have the option of investing directly in the shares of a foreign company (as opposed to using a pooled fund) in U.S. dollars and using U.S. standard settlement processes via the use of depository receipts (DRs).

DRs are negotiable certificates issued by a U.S. bank representing shares of a foreign stock, with the price of the DR relating directly to the price of the foreign stock in its home market. The issuing broker manages both the tracking to the local share price and any currency movements, for which a fee is charged. DRs are transacted in the same way as domestic securities in terms of clearance, settlement, transfer and ownership.

As Exhibit 31 shows, a significant number of companies from developed, emerging and frontier countries have used this method to raise capital and develop a liquid market for their shares in the United States. The majority of them are large-cap firms, with some mid-cap companies also taking advantage of the DR market to access capital.

Exhibit 31: Depositary Receipts by Country ClassificationTotal = 3,110

Source: BNY Mellon, 2009

Emerging 1,482, 48%

Developed 1,482, 48%

Fledgling 52, 2%Frontier 141, 5%

The demand for international investing has been driving growth in the DR market with total investments in DRs totaling more than $1.2 trillion in March 2008, a 36% increase from 2007. Exhibit 32 shows the increase in DR trading volume as a whole, with a record $4.4 trillion in trading volume in 2008. DR issuers from BRIC countries dominated the market, accounting for over 50% of the trading volume.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 29

Exhibit 32: Growth in Annual Depository Receipt Trading Volume

Source: BNY Mellon

1999 200220012001 2003 2004 2005 2006 2007 2008

5,000

4,000

3,000

2,000

1,000

0

Trad

ing

Volu

me

(Bill

ions

$)

The ability to invest in a foreign company as in a domestic company enables DR investors to avoid the costs and risks of investing directly in local markets. Currency fluctuations, costs for local custodian settlement, safekeeping charges and foreign taxes on transactions are eliminated. Dividends are also paid in U.S. dollars, providing a greater level of transparency to these transactions.

There are different types of DRs. Some are unlisted and trade as over-the-counter stocks, while others are listed on the New York Stock Exchange (NYSE) or NASDAQ and so are registered with the U.S. Securities and Exchange Commission (SEC) and required to adhere to GAAP accounting and reporting principles. Lastly, for institutional investors, Rule 144A6 and Regulation S7 securities are available. These typically private placements are reserved for qualified institutional buyers (QIBs), who are described as sophisticated investors who understand the risks of investing in these instruments.

Fees for investing in DRs are limited to the fees charged by the issuing broker to either perform the initial conversion or to simply buy the DR shares from another existing investor. Typically, once there is a liquid market, about 95% of trading is done between investors, rather than issuing new shares. Standard domestic custody and safekeeping fees also apply. Building an internationally diverse portfolio from DRs would require an evaluation of the intended investment strategy and the required cost and effort compared to simply investing in a pooled fund.

direct Investment

Investing via mutual funds, ETFs and DRs allows investors to gain exposure primarily to the equity capital markets of developed and emerging markets, whereas direct investing via the purchase of tradable instruments on local stock exchanges offers investors a greater number of options.

All the international markets in the MSCI Developed Markets and MSCI Emerging Markets indices have existing stock exchanges and most allow foreign investors to purchase securities and deal locally on those exchanges.

6 Rule 144a is an SEC rule that modifies a two-year holding period requirement on privately placed securities to allow institutional buyers to trade those positions among themselves, substantially increasing the liquidity of the related securities.

7 Regulation S has been amended to bring its concepts more in line with Rule 144, with the objective of reducing fradulent practices in offshore offerings of equity securities.

30 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

direct Investing in developed Markets

Other than the United States, the Japanese and European capital markets are the most developed in the world. Many developed countries have more than one stock exchange and offer numerous tradable instruments, including equities, warrants, options, bonds, derivatives, unit trusts, commodities, rights, indices, futures and debentures. Exhibit 33 below shows a partial listing of stock exchanges, along with some of the risks and country-specific rules and regulations that investors should consider.

Exhibit 33: Developed Countries Direct Investment

Country Exchange Type Exchange Name Details/Comments

France primary stock euronext (does not include nYse euronext)

tax– Investors pay a flat 16% capital gains tax– dividends paid to non-residents are subject to a 25%

withholdings tax

ease of entry– According to the u.s. state department, the formal French

investment regime remains the least restrictive in the world

United Kingdom

primary stock london stock exchange tax– A 20% withholding tax applies to dividends paid

to foreigners by reIts– Interest income paid

ease of entry– the united Kingdom does not discriminate between

uK nationals and foreign investors except in a few exceptional circumstances

Futures/options/derivatives

edX london

ICe Futures europe

the Baltic exchange

london Metals exchange

Germany

primary stock deutsche Börse AG tax– All dividends distributed to foreign investors (non-

residents) are also subject to the flat withholding tax of 25%

ease of entry– German law offers foreign investors national treatment

Futures/options/derivatives rMX Hannover

Commodities european energy exchange

Japan

primary stockosaka stock exchange

tax– dividends distributed to foreign investors are subject

to a withholding tax of 20%– Interest distributed to foreigners is subject to a

withholding tax of 20%– Investors are taxed on gains from the sale of shares at

20% (however, through december 2008, this rate is 10%)

ease of entry– Japan maintains no formal restrictions on inward

portfolio investment

tokyo stock exchange

Futures/options/derivatives

Kansai Commodities exchange

tokyo Commodity exchange

tokyo Financial exchange

Futures/options/derivatives/Commodities

Central Japan Commodity exchange

Canadaprimary stock/ Futures/options/derivatives/Commodities

tsX Group

tax– dividends paid to foreign investors are subject to a 25% tax– Interest paid to non-residents is subject to a 25% tax

ease of entry– Canada offers full national treatment to foreign investors

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 31

direct Investing in the BrIC Markets

The BRIC countries offer equities, derivatives, commodities and other instruments to local investors. Many of these instruments are not available via mutual funds or ETFs. As Exhibit 34 illustrates, there is significant liquidity, but also some country-specific risks.

Exhibit 34: BRIC Countries Direct Investment

Country Exchange Type Exchange Name Details/Comments

Brazil primary stock/ Futures/options/derivatives

BM&F Bovespa (on May 8, 2008, the Brazil Mercantile & Futures exchange merged with the são paulo exchange to create the BM&F Bovespa exchange)

tax– Investors pay 15% capital gains tax– Interest paid to foreign investors is subject to a 15% tax

ease of entry– Foreign investors are required to maintain a presence or

appoint a representative broker or institution– the past closure of stock exchanges due to market

volatility raises questions on liquidity risk

Russia primary stock

rts stock exchange

tax– Foreign investors pay a 30% capital gains tax and a 15%

income tax on dividends– Foreign investors pay a 20% tax on interest income– A 13% tax is levied on the sale of shares– the past closure of stock exchanges due to market

volatility raises questions on liquidity risks

ease of entry– Investing in russia is difficult for foreign investors due

to the lax and shifting regulatory environment. laws and regulations are often murky

– A new law passed in March 2008 limits foreign investments in certain industries deemed to be of strategic significance by russia’s parliament

Moscow Interbank Currency exchange

India

primary stock

Bombay stock exchangetax– Foreign investors pay a 30% short-term capital gains tax

and a 10% long-term capital gains tax– A 10% tax rate is levied on interest income received

ease of entry– Foreign investors investing in India must register with the

securities and exchange Board of India (seBI)– India has caps in place on the quantity of shares foreigners

can own and these vary by sector and type of investing instrument

national stock exchange

Commodities Multi Commodity exchange

China

primary stock

shanghai stock exchange tax

– there are no capital gains taxes– A 10% witholding tax is levied on dividend income for

foreign investors– Foreigners pay a 10% tax on interest income received—

however, for residents of Hong Kong this is reduced to 7%

ease of entry– A changing regulatory environment can prove to be

challenging for foreign investors– A limit on foreign investors purchase of locally traded

instruments is strictly enforced using a quota system

shenzhen stock exchange

Futures/options/derivatives

Chinese Gold and silver exchange

dalian Commodity exchange

Zhengzhou Commodity exchange

shanghai Futures exchange

32 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

direct Investing in other emerging Markets

With an improved investment climate, international investors are increasingly becoming interested in other emerging markets that are showing positive GDP growth. Exhibit 35 shows a selection of these countries. Although they have less liquidity than the BRIC countries, these developing markets offer foreign investors opportunities to invest locally in stock markets and, in some cases, in derivatives and futures instruments.

Exhibit 35: Non-BRIC Emerging Countries Stock Exchanges

Country Exchange Type Exchange Name Details/Comments

Mexico

primary stock Bolsa Mexicana de valores

tax– Interest paid to foreigners is subject to a withholding tax

rate of 4.9%– there are no dividend taxes

ease of entry– Mexico is open to foreign direct investment (FdI) in most

economic sectors and has consistently been one of the largest recipients of FdI among emerging markets

Futures/options/derivatives

Mexican derivatives exchange

Turkey

primary stock Istanbul stock exchange

tax– dividends paid to non-residents are subject to 15%

withholding tax– A 10% interest income tax is assessed on foreign investors– Capital gains derived from the sale of securities are

subject to income taxes subject to a detailed schedule of holding periods

ease of entry– According to the u.s. state department, turkey has one of

the most liberal legal regimes for investment in the oeCd– However an excessive bureaucracy, a slow judicial system,

high taxes lead to a highly inefficient legal and regulatory environment

Commodities Istanbul Gold exchange

Malaysia

primary stock Bursa Malaysia

tax– no taxes are assessed on dividend income– A withholding tax of 15% applied to non-residents on all

interest income– there are no capital gains taxes

ease of entry– According to a World Bank survey Malaysia ranks third

in protecting investors—both local and foreign– Malaysia limits foreign investors’ participation in the

financial services sector

Futures/options/derivatives

Bursa Malaysia derivatives

Chile primary stock Bolsa de Comercio de santiago

tax– All interest is subject to a 35% holding tax

ease of entry– Credit is allocated on market terms and is available to

foreigners, although the Central Bank does reserve the right to restrict foreign investors’ access to internal credit if a credit shortage exists

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 33

Costs

Costs for investing usually include brokerage commission and custodian fees for the settlement and safekeeping of assets in local markets. Portfolio accounting and administration costs are typically charged by custodians. Costs vary among markets and providers. Institutions frequently use a sliding scale arrangement in which costs decline as assets or trade volume increase.

For an international institutional investor, four major types of fees are charged when investing locally.

AUM or portfolio-based fees are typically charged in basis points:

1. Asset safekeeping charges

2. Portfolio accounting and administration charges

Transaction fees are charged per trade, which can be charged either as a straight fee or in basis points:

3. Brokerage commissions

4. Settlement transaction charges

Asset safekeeping charges vary widely among countries. These charges are typically the lowest in the United States, where fees are usually under 1 basis point per annum. Safekeeping fees in Europe are typically higher due to the fragmented nature and complexity of the post-trade infrastructure in the region. Fees in emerging and frontier countries are even higher, in some cases over 50 basis points. So for a $1 billion portfolio, charges for a U.S.-only portfolio could be under $100,000 per year or they could be over $5 million for a portfolio that is 100% allocated to emerging and frontier assets.

Charges for portfolio or fund accounting and administration are usually much more standardized, regardless of the asset type in the portfolio. These typically range from 2 to 10 basis points, depending on the amount of services required.

With brokerage commissions, the United States is the least expensive, while international commissions are substantially higher. Elkins-McSherry, a transaction cost analysis provider, estimates average costs for U.S. trades at 8.46 basis points, 18.30 basis points for European Union trades and a global average of 22 basis points. These costs include commissions plus local taxes and fees.

Settlement transaction fees are also market specific, with the developed markets significantly less expensive than emerging or frontier markets.

Flexibility

For international investors considering direct investing, a cost/benefit analysis should be undertaken to determine whether direct investing is economically viable, or whether investment in pooled funds or DRs would be more effective. A direct investing approach provides greater flexibility in an investment portfolio, as well as access to a greater range of international instruments than those covered by mutual funds and ETFs, which tend to be heavily weighted towards equities.

Direct investing requires the investor to leverage service providers for international access to both developed and emerging global markets.

34 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

risks

The increase in the number of local tradable assets is counterbalanced by the risk of direct investing. For example, investors in foreign markets are subject to local laws and regulations regarding capital adequacy, tax payment and profits repatriation. In addition to these regulatory challenges, foreign investors must also manage potentially adverse foreign exchange and local interest rate risks for fixed income investments. While these risks bear an upside potential, they could also significantly harm foreign investors if mismanaged.

A number of developed and emerging markets have treaties with one another to prevent double taxation of their citizens who may be investing abroad. These treaties vary by country, investor class and tax type. Direct foreign investors should be familiar with tax treaties of countries in which they intend to invest as the tax relief they receive could boost their investment returns.

A direct investor in international markets, particularly in emerging market countries, may see potentially greater returns, but could also face a range of risk profiles that do not exist in most developed markets. The inability to buy or sell based on investor preference, such as liquidity risk, is a key consideration. Liquidity risks are significantly higher in emerging markets predominantly due to the relative immaturity of these capital markets. In addition, there can be more restrictions on order types. For example, the short selling of securities in China is prohibited, which would inhibit the execution of some investing strategies. Also, the lack of robust derivatives markets in emerging markets may hamper investors who want to hedge their investments locally.

However, this situation is changing. For example, the combination of Brazil’s futures and equities exchanges—the BMF and Bovespa merger in May 2008—should significantly improve the synergies and volumes of the futures, options, derivatives and equity markets in Brazil. Both local and foreign investors will be able to access most markets on the same platform and exchange, and the expected increase in trading volume will help reduce the liquidity risk of the Brazilian capital markets.

Getting startedInternational investing carries risks that are unique to international markets, necessitating an evaluation of areas such as currency, liquidity and political and economic risks. A service provider helps to mitigate these risks by providing critical research and specialist support in managing these areas.

risks related to International Investing

Investors must consider a number of risks before constructing an international portfolio. Risks are dictated, in part, by the geographical scope of the investment: a broad international portfolio; a more limited portfolio focused on either emerging markets or developed markets; and a portfolio focused on a specific region, such as Europe or Latin America, or a specific country or countries. The profile of the international portfolio informs the risk evaluation.

> Currency Risk—Foreign investment returns depend on both the local currency exchange rate value against the U.S. dollar and the stock price of the local currency.

> Liquidity Risk—The typically lower trading volumes in international markets, as compared to the United States, and the fact that a number of developing countries allow foreign investors to purchase only a limited quantity of specified classes of securities, reduce the liquidity of these markets.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 35

> Political and Economic Risk—Political events have the potential to destabilize returns from foreign markets. Particularly in emerging markets, macroeconomic conditions remain relatively volatile with historical policy changes such as currency controls, taxation changes and trade restrictions negatively affecting foreign investors.

In addition to these fundamental risk considerations, investors must also consider informational issues. Obtaining financial information on specific foreign companies may be problematic since accounting and financial disclosure practices can vary widely from U.S. standards.

leveraging pershing for direct Investment

Investing directly in foreign markets via the purchase of tradable instruments on local stock exchanges typically requires a relationship with a local broker-dealer. Pershing offers efficient access to a breadth of local brokers in various international markets, and investors can leverage these relationships when trading.

Leveraging Pershing for Direct Investment

Sophisticated services:Direct access

Preliminary services:Indirect access

No Internationalaccess

Inte

rnat

iona

l Cap

abili

ties

Pershing

Other major service providers

Regional players

Maturity

Pershing is a leader in the direct investment market and provides a complete suite of services:

> Global execution capabilities for equities, fixed income and derivatives

> Multicurrency support, thus offering execution capabilities in non-U.S. dollars along with foreign exchange solutions

> Global custodian capabilities with connectivity to various industry utilities and international depositories

> Transparent and flexible reporting with multicurrency statements

> International algorithmic trading (including TWAP, VWAP, implementation shortfall and percentage of volume)

> Dedicated support 24 hours a day, 6 days a week, with a single point of contact

> International access through American Depositary Receipts (ADRs)

Pershing also provides a robust technology infrastructure, which includes straight-through-processing capabilities (in markets where permissible), and seamless integration capabilities with various third-party solutions and applications.

36 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

one-stop shop

Pershing gives independent advisors a competitive edge in meeting growing investor demand for international portfolio diversification.

Pershing can help you manage the additional complexities and risks related to international investing with a true one-stop shop. Pershing offers a complete range of trading, operational support and diverse investment options across different geographical regions and provide local market knowledge and expertise around potentially complex regulations and legal challenges including risk management. In addition, Pershing provides a consultative relationship by offering education and support for dynamic regulations such as alterations in the access of different types of vehicles and changes in the investment landscape, especially in the emerging economies.

A partnership with Pershing provides registered investment advisors (RIAs) with more transparency into the international investment process. RIAs who identify investment opportunities early and redirect investments appropriately will benefit from Pershing’s extensive capabilities and support.

Movement from Global Investment Banks

Pershing meets the needs of independent firms who increasingly desire pure-play custody and brokerage services. These firms look to providers who have a strong balance sheet and are less exposed to the effects of the credit crisis. This era of financial transformation creates a unique opportunity to form stronger strategic partnerships. By not directly competing with an investment firm’s business and by not taking positions in the firm’s transactions, Pershing offers a relatively low-risk and high-reward proposition, thus ensuring reliability and safety for the investment firm.

When evaluating a provider, consider Pershing’s comprehensive services and robust infrastructure. Add to those Pershing’s strong industry reputation, leading track record and a growing customer base, and you will find Pershing a natural choice as your firm’s strategic partner for international investments.

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 37

Appendices

MsCI Market definitions

Criteria Frontier Emerging Developed

A. Economic Development

A.1 sustainability of economic development no requirement no requirementCountry GnI per capita 25% above the World Bank high income threshold* for 3 consecutive years

B. Size and Liquidity Requirements

B.1 number of companies meeting the following standard index criteria 2 3 5

Company size (full market cap)** usd 434 mm usd 857 mm usd 1,734 mm

security size (float market cap)** usd 34 mm usd 434 mm usd 857 mm

security liquidity 2.5% Atvr*** 15% Atvr 20% Atvr

C. Market Accessibility Criteria

C.1 openness to foreign ownership At least some significant very high

C.2 ease of capital inflows/outflows At least partial significant very high

C.3 efficiency of the operational framework Modest Good and tested very high

C.4 stability of institutional framework Modest Modest very high

* High income threshold for 2007: GNI per capita of USD 11,456 (World Bank, Atals method).

** Minimum in use for the May 2008 Semi-Annual Index Reviews, updated on a semi-annual basis.

*** Annual Traded Value Ratio (ATVR)

Methodology

Description of the methodologies used to develop analytical charts.

section 2

Footnote 1: In addition to stock exchanges, there has also been high growth in the number of fixed income and derivatives exchanges. For the purposes of this study, fixed income and derivatives-only exchanges were excluded. Many of the stock exchanges included in this study listed and traded multiple instrument types, but all traded common shares at a minimum.

exhibit 3: Comparison of returns in equities and Bonds Across different regions, 2003–2009

> Equity indices – MSCI – Return is a six-year compounded return.

> Bond indices – Citi (Solomon) – Return is a six-year compounded return.

> EM includes BRIC and other EM Asian countries, Latin America and Eastern Europe.

> Sharpe ratio is calculated using a five-year compounded return and a 2% risk-free rate.

> Monthly indices used to derive the return, standard deviation and correlations include the following:

– MSCI All World index used as a proxy for all world equities

– MSCI USA Standard Core index used as a proxy for U.S. equities

– MSCI EM Standard Core index used as a proxy for emerging markets equities

38 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

– MSCI World, excluding U.S. Standard Core index, used as a proxy for world (excluding U.S.) equities

– Citigroup World Broad Investment Grade index used as a proxy for all world bonds

– Citigroup U.S. Broad Investment Grade index used as a proxy for U.S. bonds

– Citigroup Europe Broad Investment Grade index used as a proxy for world (excluding U.S.) bonds

– Citigroup Emerging Markets Broad Investment index used as a proxy for emerging markets bonds

exhibit 4: returns of u.s. and International portfolios

> All returns are compounded annualized returns for October 2003 to September 2009, and all standard deviations are annualized from monthly standard deviations.

> Portfolio 1: U.S.-only portfolio represents a U.S. balanced portfolio with weights in U.S. equities at 60% and bonds at 40%.

> Portfolio 2: U.S. and emerging market portfolio represents a balanced portfolio with emerging markets investments both in equities and bonds (U.S. equities at 48%, U.S. bonds at 32%, EM equities at 12% and EM bonds at 8%).

> Monthly indices that were used to derive the return, standard deviation and correlations include the following:

– MSCI All World Index used as a proxy for all world equities

– MSCI USA Standard Core index used as proxy for U.S. equities

– MSCI EM Standard Core index used as a proxy for emerging markets equities

– MSCI World (excluding U.S. Standard Core index) used as a proxy for World (excluding U.S.) equities

– Citigroup World Broad Investment Grade index used as a proxy for all world bonds

– Citigroup U.S. Broad Investment Grade index used as a proxy for U.S. bonds

– Citigroup Europe Broad Investment Grade index used as a proxy for world (excluding U.S.) bonds

– Citigroup Emerging Markets Broad Investment index used as a proxy for emerging markets bonds

section 3

The data on funds and ETFs was extracted from Morningstar’s website database on October 7, 2009.

> For international index funds, the criteria includes the following:

– Percentage of non-U.S. stock greater than 50

– Either index or enhanced index funds

– Total assets greater than or equal to $1 million

– A distinct portfolio

> For international active funds, the criteria includes the following:

– Percentage of non-U.S. stock greater than 50

– No index or enhanced index funds

– Total assets greater than or equal to $1 million

– A distinct portfolio

InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde 39

From that point, the following scheme was followed to categorize the vehicles for the charts in the paper.

Fund/ETF Category U.S. (Asset%)

International Developed (Asset%)

Emerging (Asset%)

Global >25% 0–75% 0–75%

International developed 0–25% >75% 0–25%

International emerging 0–25% 0–25% >75%

International developed/emerging Blend 0–25% 0–74% 0–74%

For those vehicles with no data on holdings available (approximately 20%), the Morningstar category and fund name were used as proxies and categorized accordingly.

40 InternAtIonAl InvestInG: An Independent AdvIsor’s GuIde

Pershing Advisor Solutions LLC, a subsidiary of The Bank of New York Mellon Corporation, member FINRA, SIPC. Clearing, custody or other brokerage services may be provided by Pershing LLC, member FINRA, NYSE, SIPC. Pershing Advisor Solutions relies on its affiliate Pershing to provide execution services. Trademark(s) belong to their respective owners. For professional use only. Not for distribution to the public.

this guidebook is part of a program designed to help registered investment advisors and financial services firms identify trends, enhance operations and grow revenue. It represents pershing Advisor solutions’ unique approach to practice management support—going beyond high-level guidance to offer actionable information, personalized consulting and ready-to-execute programs.

to learn more about pershing Advisor solutions, visit us on the web at www.pershingadvisorsolutions.com.

About the Authors

thomas roughan

Thomas Roughan is a Partner at Capco in the Capital Markets practice with over 20 years experience in financial services and consulting. He has led numerous business strategy, operational performance improvement, risk and control and IT assessment engagements. His client base has included broker dealers, investment managers, wealth managers, custodian banks, clearing firms, stock exchanges and depositories. Prior to joining Capco, Tom worked for Ernst & Young Management Consulting in their Financial Services practice and with State Street Bank in the Institutional Investor Services division.

darren Appannah

Darren Appannah is a Managing Principal in Capco’s Capital Markets practice. Darren is responsible for the delivery of strategy and business transformation focused projects for clients including global banks, broker dealers, wealth and investment managers, clearing firms and stock exchanges. Darren has led the research and development of a number of thought pieces and contributed to Capco’s leading-edge thinking on a number of industry topics. Prior to joining Capco, Darren worked for Ernst & Young Management Consulting in their Financial Services practice, focusing on managing large-scale business transformation projects.

30123GB-pAs-GlB-5-10

About us

pershing Advisor solutions llC (member FInrA/sIpC) is an affiliate of pershing llC and a leading custodian to independent registered investment advisors and

dually registered advisors working in conjunction with many of pershing llC’s introducing broker-dealer customers. pershing llC (member FInrA/nYse/sIpC),

a BnY Mellon company, is committed to delivering dependable operational support, robust trading services, flexible technology, an expansive array of investment

solutions, practice management support and service excellence. through an innovative custody platform, pershing Advisor solutions delivers superior expertise and

scalable and customizable solutions to help independent registered investment advisors manage and grow their businesses. Additional information is available at

www.pershingadvisorsolutions.com.

About Capco

Capco is a leading global provider of integrated consulting, technology, and transformation services dedicated solely to the financial services industry. our

professionals combine innovative thinking with our unrivalled first-hand industry knowledge to offer our clients consulting expertise, complex technology and

package integration, and managed services to move their organizations forward. through our collaborative and efficient approach, we help our clients successfully

increase revenue, manage risk and regulatory change, reduce costs and enhance control. In north America, we specialize in Banking; Capital Markets; Wealth and

Investment Management; Finance, risk & Compliance and technology with offices in Chicago, d.C., new York, san Francisco and toronto. to learn more, contact us

at + 1 212-284-8600 (+32 3 740 10 00 from outside the united states or Canada), or visit our Web site at www.capco.com.