International Portfolio Management Quiz

Lecture 14: Introduction to International Investing and ESG Investing

• The lecture covers international investing and ESG investing, referencing concepts from Berk/DeMarzo (BKM) Chapters 25 and 28.
• The global stock market is valued at $109 trillion in 2023.
• The US is home to 39 of the 100 largest companies globally.
• Emerging markets are projected to have higher earnings growth in 2024 compared to other regions.
• US investors hold significant amounts of foreign equities, the amount fluctuating over time.

International Roadmap

• The World Market Portfolio includes international trends and diversification, efficient frontiers, and practical implications.
• Common objections to international diversification include the optimal weighting for these investments.
• Key takeaways from the lecture are about international finance.

International Diversification

• The size of foreign markets supports international diversification for US investors.
• International diversification can potentially improve diversification through moving money abroad.
• It examines correlations and its implications on the efficient frontier.

Basic Reasons to Invest Abroad

• Diversification benefits passive and active investors by reducing volatility and mitigating prolonged negative returns, including potential extreme upside.
• International investments can offer growth opportunities for active investors.

Correlations Across Countries

• This section presents correlations between various countries, such as US, China, Japan, HK, Korea, and Canada, from 1991-2009.
• Correlation values are shown in a table.

Efficient Portfolios

• The problem of identifying efficient portfolios for a given number of securities is similar to optimizing multiple assets while considering factors like variance, correlation, and constraints..
• This entails computational skills in linear programming. The key formula demonstrates minimizing portfolio variance subject to expected return.

International Allocation

• Different financial institutions provide asset allocation recommendations.
• Mutual fund distributors and financial advisors suggest varying percentages for international investment, with values often falling within a 5–40% range for foreign stocks.

Common Objections to International Diversification

• International markets can be more volatile than domestic markets.
• Currency risk adds to potential investment hazards.
• Investors may believe they can achieve similar returns in domestic markets.
• International markets can move together more than in the past, potentially reducing diversification benefits in down markets.
• Diversification may not consistently work well during market downturns.

Currency Risk

• This examines possible negative correlations between currency risk and security risk in international diversification.
• Currency risk must be considered and may offset diversification benefits.
• The formula outlines calculation of currency effects for stocks trading internationally with different currencies.

ESG Roadmap

• This covers background, growth, value vs. value perspective on ESG investments, performance evidence, greenwashing concerns, and thoughts about the future.
• Academic evidence on ESG return performance exists, but opinions are mixed across studies, regarding performance versus conventional investment strategies, and the need for clear objective criteria and investment opportunities.

ESG Methodology

• ESG stands for Environmental, Social, and Governance factors and concerns.
•  It's a concept that emerged in the early 2000s with initiatives from the UN.
• The idea is responsible business practices that involve environmental and social considerations, used in financial analyses and institutional asset management.
• Many institutions have adopted ESG guidelines since the 2000s.

Interest in ESG over time

• Interest in ESG-related topics globally, particularly compared to corporate social responsibility, has risen and fallen in popularity over time.

Other Measures

• Investment policy instruments have increased globally, as have global sustainability reporting demands.
• Many organizations and investment institutions are adhering to ESG principles across a broad and significant market capitalization.

Greenwashing Concerns

• This outlines the challenges of measuring ESG. Concerns have been raised about some companies overhyping or faking their ESG efforts ("greenwashing").
• Some studies have shown a disconnect between stated ESG goals and actual performance, causing investor confusion and distrust.
• Issues surrounding conflicts of interest in ESG ratings and data breaches are identified.

Recent News on ESG Fund Return Performance

• Recent news indicates concern about decreasing returns from ESG investments, though overall funds still seem to be outperforming those without ESG requirements.
• Low ESG risk has been noted to perform well in crises.

ESG Backlash

• Pushback against ESG investments is evident as evidenced by investor action.
• Some states have passed laws banning the use of ESG criteria in state and/or local government investment decisions.
• Some hedge funds successfully challenged and won a number of board seats at major fossil fuel-based firms.

Other Thoughts...

• This section provides additional considerations for investors.
• Discussions emphasize if firms should focus primarily on profit maximization, or acknowledge stakeholder preferences.
• It also touches on the choice of preferences or values, along with the appropriate degree of emphasis placed on such issues.

What To Do?

• This section focuses on how investors can determine a company's valuation based on estimated data versus what is actually occurring in the market, and then invest based off of the potential outcomes.
• It uses a formula for estimation.

ESG Questions for Thought

• The use of stakeholder preferences versus profit maximization in determining corporate action and valuation is covered.
• Questions posed include which preferences or values investors should use in decisions.
• How much should ESG issues factor into investment decisions is discussed.

Conclusions

• ESG definitions vary by context highlighting the need to evaluate investments in light of particular frameworks.
• ESG principles can be financially material, particularly for long-term investors, due to factors like risk management and return opportunities.
• Measuring ESG efforts, particularly avoiding greenwashing, is often difficult.
• ESG concerns should be considered in light of how difficult they are to objectively measure.

Test your knowledge on portfolio risk and variance in international markets. This quiz covers topics such as stock variance, U.S. portfolio risks, and the impact of currency fluctuations on investments. Understand the risks and benefits of international diversification and its implications for investors.