Global Diversification 2-2

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Globalization of Financial Markets Tristyn Huet-Heart Southern New Hampshire University FIN-640-Q2361 Investment Analysis & Portfolio Management December 17, 2023 Dr. Geoffrey VanderPal

Globalization of Financial Markets Any individual getting started in developing an investment portfolio has a plethora of different decisions to make including the types of investments, risk appetite and whether to invest in domestic and/or international markets. After deciding the level of risk that one is willing to assume, the next decision would be what types of strategy would provide the most benefit short-term and long-term goals of the investor. International and domestic markets provide different benefits, risk exposure, and employ different investment strategies. International vs Domestic Markets International and domestic markets offer investors with the opportunity to create a diversified investment portfolio and hedge against risks that might pertain to one market or the other. One of the primary differences between the two markets is the difference in calculation returns on foreign investments. “The return on a foreign investment is affected by the return on the assets within its own market and the change in the exchange rate between the security’s own currency and the currency of the purchaser’s home country.” (Elton, Gruber, Brown, & Goetzmann, 2014) International markets also differ from domestic markets by having an additional layers of risk exposure including, currency exchange risk, differences in financial reporting standards, political risk, and foreign taxes and regulations. (Consumers Credit Union, 2023) International Securities International securities play a vital role in corporate portfolios. Investors look to add international securities into portfolios in efforts to captivate emerging opportunities, reduce risks and create a diverse portfolio. Considering a real-world example, an analysis of the Chinese capital market compared to the United States market has shown a lot of variability with respect

to the recovery in the economy since the 2020 Covid-19 Pandemic. “ While the pandemic has increased global development risks, led to a rise in protectionism and unilateralism, China has expanded its opening up and actively led the globalization process,” ultimately propelling global economic governance and supporting the confidence in the international finance market. (World Economy News, 2021) Despite other countries, including the United States, struggling to economically recover after the pandemic, China’s economy has stabilized, providing investors with the opportunity to benefit as other global economies are still recovering. “Recent evidence shows that in financial crises, correlation in equity returns goes up and that the risk reduction properties of international diversification are reduced and possibly eliminated in these crashes.” (Elton, Gruber, Brown, & Goetzmann, 2014) An investor with both international and domestic securities would have the benefit of engaging in emerging Chinese market while offsetting the risk exposure of the struggling U.S. market. This scenario provides a prime example of the role that international markets play in corporate portfolios. Risk Levels There are several measures that investors can quantify the risk levels between domestic and foreign securities. Modern portfolio theory (MPT) quantifies investments considerations beyond expected risk and return through the applying a standard deviation to domestic and foreign markets and measuring the correlation coefficients between different countries. Historically, international diversification has provided investors with low-risk portfolios based on the concept of market correlation which says, “that the stocks in one country tend to move together, however, stocks in different countries did not.” (Elton, Gruber, Brown, & Goetzmann, 2014) The variability of the movement in stocks between different countries can be

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quantified with correlation coefficients that determine the direction and velocity of change that one markets may move in relation to one another. Correlation coefficients are determined by calculating the monthly returns on market-weighted indexes computed by Morgan Stanley Capital International (Elton, Gruber, Brown, & Goetzmann, 2014) . M arkets that have a positive coefficient, move in the same direction, while negative coefficient’s move in the opposite direction which create diversification and reduce risks. The second method of quantify risk is the measurement of standard deviation on market indexes, which measure the volatility of the market being examined. The standard deviation measures the spread in which an asset can sway from the average price. If there are significant fluctuations in prices, the standard deviation and thus volatility is high risk, whereas a lower standard deviation indicates less risk. “It should be emphasized…that the standard deviation is calculated on market indexes and is therefore a measure of risk for a well-diversified portfolio, consisting only of securities traded within the country under examination.” (Elton, Gruber, Brown, & Goetzmann, 2014) Asset Allocation Strategies Asset allocation strategies and weighting are imperative decisions that should be made when making international investments to best align with an investors long-term and short-term goals. Asset allocation strategies aids investors in deciding on an appropriate mix of international and domestic securities as well as industry mix that will produce the expected returns and assume the investor’s risk appetite. Some different strategies to consider are strategic asset allocation, constant-weighting, tactical, dynamic, and insured asset allocation. Strategic asset allocation assumes that an investor will hold the same proportion of assets, despite changes in values, whereas weighted asset allocation involves the constant rebalancing of

assets as values shift in the market. “A common rule of thumb is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.” (Investopedia Team, 2021) Dynamic and tactical approaches involve a more detailed analysis of current market movement and projections and adjusting the mix of assets to take advantage of short-term returns. An insured asset allocation, often used by risk-adverse investors, sets a base portfolio value, and aims not go below the base through active management to increase the portfolio value. Different approaches to asset weighing and asset allocation strategies will provide investors with different returns and risk exposure; the decisions should be made to be fit return expectations and risk tolerance. (Investopedia Team, 2021) Conclusion As investors navigate through the various decisions that need to be made in any investment, they must consider the benefits, risks, risk appetite and different strategies to achieve profitable returns. Investors also need to understand the primary differences between international and domestic markets as well as the risks that need to be considered. A successful investment portfolio is one that has strategic asset allocation management and holds an appropriate proportion of international and domestic securities to best fit an investor’s expectations.

References Consumers Credit Union. (2023, October 12). Global vs International Stock Markets: What’s the Difference? Retrieved from Consuemrs Credit Untion: https://www.consumerscu.org/blog/global-vs-international-stock-markets-whats-the- difference#:~:text=International%20investments%20carry%20additional%20risks,in %20greater%20share%20price%20volatility. Elton, E., Gruber, M., Brown, S., & Goetzmann, W. (2014). Modern Portfolio Theory and Investment Analysis (Vol. 9th ed.). Hoboken, NJ: John Wiley & Sons. Investopedia Team. (2021, December 4). 6 Asset Allocation Strategies That Work . Retrieved from Investopedia: https://www.investopedia.com/investing/6-asset-allocation-strategies- work/ World Economy News. (2021, 05 20). Increasing Attractiveness to Foreign Investment Demonstrates China’s Well Managed Regulatory Environment . Retrieved from Hellenic Shipping News Worldwide: https://www.hellenicshippingnews.com/increasing- attractiveness-to-foreign-investment-demonstrates-chinas-well-managed-regulatory- environment-2/

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