1. Chapter 12 Internationalization of Mutual Funds Viewing recommendations for Windows: Use the Arial TrueType font and set your screen area to at least 800 by 600 pixels with Colors set to Hi Color (16 bit). Viewing recommendations for Macintosh: Use the Arial TrueType font and set your monitor resolution to at least 800 by 600 pixels with Color Depth set to thousands of colors

2. Copyright © Houghton Mifflin Company. All rights reserved. 12–1 Market Capitalization, in $ Billions Source: SIA 2001 Securities Industry Fact Book Size of Global Equity Markets

3. Copyright © Houghton Mifflin Company. All rights reserved. 12–2 Source: Reprinted by permission. Goldman, Sachs Global Investment Research. Note: Excludes emerging markets. Increasing Importance of Global Sector versus Local Market

4. Copyright © Houghton Mifflin Company. All rights reserved. 12–3 Gross Transactions in Foreign Stocks by U.S. Investors $ Billions Source: SIA 2001 Securities Industry Fact Book

5. Copyright © Houghton Mifflin Company. All rights reserved. 12–4 Challenges of Foreign Investing Investment issues –Conducting research on foreign companies –Restrictions on shareholders’ role in foreign companies Trading costs –Illiquidity of foreign markets –Difficulties in obtaining prices Regulatory issues –May need government permission to buy securities –May be caps on foreign ownership Currency Risk –Exchange rate fluctuations increase return volatility Political Risk –Government policies may change toward foreign investors –Unexpected political problems may increase market risk Operational Risk –Some markets use physical stock certificates –Some markets do not have centralized / efficient settlement

6. Copyright © Houghton Mifflin Company. All rights reserved. 12–5 Benefits of Investing Through Mutual Funds Reduced administrative costs = key reason for investing in an international mutual fund versus investing directly in foreign securities Fund managers can use their size to constrain high transaction costs of foreign markets Fund managers can obtain more information on foreign companies than most individual investors

7. Copyright © Houghton Mifflin Company. All rights reserved. 12–6 Benefits of Investing Through Mutual Funds (cont.) Fund custodians can better obtain proxies, receive dividends, pay transaction taxes, and transfer stock certificates in foreign countries Still exposed to political and currency risk, although some funds try to reduce or eliminate currency risk by hedging

8. Copyright © Houghton Mifflin Company. All rights reserved. 12–7 Flows Into U.S. Foreign Equity Mutual Funds * $ Billions Source: Investment Company Institute (ICI) *includes net new cash flow

9. Copyright © Houghton Mifflin Company. All rights reserved. 12–8 Main Models for a Global Mutual Fund Business Mutual recognition –Fund organized in one country may be distributed in multiple countries without the need to re-register in each one –Currently difficult to achieve as most countries are reluctant to relinquish control over regulating financial services –Most countries instead practice “national treatment”

10. Copyright © Houghton Mifflin Company. All rights reserved. 12–9 Main Models for a Global Mutual Fund Business (cont.) Master-feeder fund –Multiple feeder funds, each designed to meet needs of the local market, invest in one master fund (often organized offshore) –Such funds are legally and administratively complex –Such funds may be prohibited in certain circumstances

11. Copyright © Houghton Mifflin Company. All rights reserved. 12–10 Main Models for a Global Mutual Fund Business (cont.) Cloning –Multiple funds with almost identical investment policies are managed in parallel so as to have virtually identical investment portfolios –Difficult to take advantage of economies of scale –Some “clones” may require separate, time- consuming treatment by the manager –Some management companies may instead use “templating”

12. Copyright © Houghton Mifflin Company. All rights reserved. 12–11 EU: European Union Positive trends –UCITS (an EU directive) spells out one of the most advanced mutual recognition systems in the world –Many countries are pursuing pension reforms, including privatized DC plans

13. Copyright © Houghton Mifflin Company. All rights reserved. 12–12 EU: European Union (cont.) How mutual recognition system works –To sell a fund, U.S. fund sponsor must incorporate a new fund in an EU jurisdiction and follow EU rules –To sell an EU fund, after registered in one qualifying EU country, the fund can be offered for sale in other countries by filing a simple notice –Host EU country must impose certain minimum conditions Modest compared to U.S. Investment Company Act of 1940 Host country has considerable discretion

14. Copyright © Houghton Mifflin Company. All rights reserved. 12–13 EU: European Union (cont.) Challenges –Automatic registration does not cover local marketing Funds must comply with marketing rules of each jurisdiction, which may be used to undermine usefulness of the UCITS –EU country of fund sale also retains jurisdiction over “other” areas –Each country still has its own unique set of tax laws and market practices

15. Copyright © Houghton Mifflin Company. All rights reserved. 12–14 Japan Positive trends –Aging population is producing an urgent need to reform the pension system –Country has a large middle class and one of the highest world savings rates –Government has begun to lift restrictions on foreign competition in the financial services industry Challenges –Government’s progress on pension reform has been limited –Economy has been stagnant and distrust of broker-dealers and other investment managers remains –Regulatory practices may still impose restrictions

16. Copyright © Houghton Mifflin Company. All rights reserved. 12–15 Southeast Asia Positive trends –Some countries have taken steps toward economic and financial reform that may create growth opportunities for mutual funds Challenges –Many countries are still emerging from the Asian financial crisis of the late 1990s and the middle class has been diminished –Some Asian countries require a foreign company to have a local partner in order to enter the mutual fund business –Other Asian countries have relatively high capital and staff requirements for start-up fund business –Must consider expense of building own distribution system versus utilizing established network of local distributors

17. Copyright © Houghton Mifflin Company. All rights reserved. 12–16 North and South America Latin America –Positive trend: long-term opportunities are quite good, due to Overall wealth in population Pension reform movements –Challenges: near-term opportunities for fund managers are limited Wealth is concentrated in a handful of a few, who may not be interested Regulations are often hostile to foreign entrants to local market

18. Copyright © Houghton Mifflin Company. All rights reserved. 12–17 North and South America (cont.) Canada –Positive trends Strong mutual fund marketplace exists Well-developed equity culture Increase in popularity of retirement savings accounts Relatively open regulatory attitude toward foreign entrants to local market –Challenges Retirement savings plans are limitations on investments outside Canada Growth of DC business in Canada has been slower than expected

19. Copyright © Houghton Mifflin Company. All rights reserved. 12–18 NAFTA: North American Free Trade Agreement Effective cloning mechanism available, but no cross- border sales within North America National treatment: foreign mutual fund is treated the same as a local mutual fund –All Mexican funds must invest in Mexican securities –Banks may advise, but not underwrite or sponsor, U.S. mutual funds Reciprocity: foreign country applies rules of home country –Mexican mutual funds, sponsored by U.S. firms, invest in all securities (like all mutual funds in U.S.) –Canadian banks may advise, underwrite, and sponsor U.S. mutual funds (like all banks in Canada)

20. Copyright © Houghton Mifflin Company. All rights reserved. 12–19 Case: Costs of Modifying Colossus and CanHolder

21. Copyright © Houghton Mifflin Company. All rights reserved. 12–20 Case Q3: Possible Fund Classifications

22. Copyright © Houghton Mifflin Company. All rights reserved. 12–21 Case Q3: Possible Profile Inputs