Investors Eye International Opportunities

Terry Flanagan

Different avenues are being explored for foreign market access.

Institutional investors continue to conduct manager selection globally, as both opportunities within the developed foreign and emerging markets steadily rise. In 2009, global consultancy Mercer helped perform manager selection for pensions, endowments and foundations on 826 occasions, and the advised global searches increased to 940 in 2010. Canadian institutions specifically have shown increased interest in foreign opportunities as global searches increased from 137 to 147 during the same time period, according to Mercer data.

“I believe global equity prices to rise by up to 30% at year-end 2012,” said one Middle Eastern sovereign wealth investor, who wished to remain anonymous.

Naturally, as foreign investors increase their attention to investing on a global scale, traders have pondered the easiest, most cost-efficient, way to access the international markets. Asian investors look to Japan, the region’s most known developed market, as its locals hope foreign interest will continue to make up for a near $300 billion drop on the Tokyo Stock Exchange in the two days after its catastrophic 2011 earthquake.

“If you look at ownership levels, you can see foreigners have bought a larger percentage of Japanese equities than they have sold over the past few years,” said David Baran, chief executive of Tokyo-based investment manager Symphony Partners. “At the same time, the percentage of foreigners buying and selling has increased substantially, probably as a function of high-frequency traders.”

When market chatter rises in specific regions among the traditional buy-side, HFT may often follow in pursuit. Baran told Markets Media that this dynamic makes Japan “a deep market”.

“There are a myriad ways to participate and make money,” he cited. “I don’t think it’s necessary to define it as long term or short term, and I also don’t think it’s a very high hurdle to get access to Japanese equity trading platforms these days.”

Still, despite which market participant you are in on the investor scale, Baran is not a fan of American Depository Receipts and noted that common stocks are readily available in Japan for foreign traders.

“I like to exercise all my rights as a shareholder so (ADRs) are really not for me,” Baran told Markets Media. “In some instances, they can be subordinate to the common stock. It’s infinitely easier to access the Japanese markets directly now than it was 10 years ago.”

Of course, cross-border investing has its challenges for all foreign markets due to different trading rules, corporate governance, disclosure requirements, and different laws. While Japan remains to be a liquid market, some investors remain tepid about more emerging and frontier markets as they can pose illiquidity risks via wide bid/ask spreads.

Perhaps to address traders’ liquidity concerns, traditional buy-side institutions have opted for closed-end funds (CEFs), which are designed to give access to investors interested in illiquid, foreign securities.

Traders that obtain foreign market access via a CEF can also win points with their portfolio managers as CEFs often tend to steadily offer dividends.

“CEFs are cheap from a valuation standpoint, with decent earnings and good sized cash reserves,” said Michael Jabara, head of exchange-traded funds and CEF research at Morgan Stanley Smith Barney.

CEFs can mitigate some of the risks found in traditional international equity investing and provide competitive risk-adjusted returns and diversified international exposure across countries mainly because CEFs sell at a discount to the sum of their stock constituents, or their net asset value, versus the full price investors pay for individual equities.

Yet, the biggest concern with CEFs may be their cost. To invest in a closed-end fund, you’ll have to pay a commission on trades as well as fund expenses and high annual management fees that range from 1% to 2% of a specific investment. To hold costs down, many buy-side firms look for closed-end funds with low expenses and fees, and consider trading shares through a discount brokerage. Many buy-side traders rely on transaction cost analysis (TCA), a developing process that has been made possible by advancing technologies.

“Buy-side traders want transaction cost analysis that can analyze implicit and explicit costs on a historical and real-time basis,” said Peter Simpson, senior vice-president of research and development at Panopticon, a provider of real-time visual data analysis.

“TCA needs to also measure slippage for the buy-side, and represent trades that represent lost opportunities from the time orders are placed to the final price obtained,” Simpson said. “High-frequency traders have it hard for investors and the buy-side to achieve the best alpha.”

Simpson highlighted that tools to help analyze broker performance have also become paramount.

“Buy-side, sell-side, and quantitative trading want the ability to build their own trading platforms, and push their capabilities for a cross-asset class trading platform,” he said, citing a convergence of global equity, options, futures and foreign exchange trading on one platform.

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