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Few investors dispute the potential for investment growth internationally. The
opportunities for financial gain in emerging markets are great. As with most
investments with large potential rewards, though, the risks can be huge.
Potential Reward
Several demographic and infrastructure statistics for India, China and Indonesia
illustrate the enormous potential in emerging market countries. These three
countries are home to about 2.5 billion people, about 42% of the world's population.
One third of these 2.5 billion people are under 15 years old. The average per
capita income for India, China and Indonesia is approximately $400 per year. The
United States per capita income is about 58 times this amount.
In the U.S. we have about seven- count them - seven phone lines for every ten
people. In India, China, and Indonesia they have about seven phone lines for every
1000 people! In addition the U.S. has the capacity to generate 50 times the
electricity per person as these three countries.
Potential Risk
A recent study done by 3 researchers at a Thai university says that 14 to 19% of
Thailand's economy is represented by illegal activities, about 30 billion dollars
worth. In fact, prostitution, which accounts for 75% of this activity, equals the
total value of Thailand's wholesale and retail trade, about 20 billion dollars.
In Russia consumer prices increased by 28% in 1996 as gross domestic production
declined by 7%. The president of the country may or may not live for six more months
and businessmen take care of the competition, not by lowering prices or providing better
service, but by murdering them -- literally.
Some of the risks of investing internationally are:
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the lack of good, reliable,
consistent company information |
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few or no exporting standards |
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accounting systems vastly different
than those in the U.S. |
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small or illiquid markets |
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high transaction costs |
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political risks |
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economic and currency risks |
So while there is much hype about investors getting into the international
marketplace there are even more uncertainties.
How to Safely Invest Internationally
We are often asked, "Does Lyon Capital Management invest
internationally?" Yes. But we do it in a manner not popularly discussed.
We invest internationally by investing in high quality U.S. based companies that have a
large portion of their business outside this country.
When one invests in a stock like IBM (our Pick-of-the-Quarter in the summer of 1996) or
Coca Cola, companies who do 63% and 71% of their total business outside the U.S., one is
in effect hiring the best foreign business managers to make decisions about foreign
markets. These managers know the market, in many cases, live in the market and are
familiar with the economic and political situations. We believe they are better
positioned to make smarter international investing decisions than we are or than are most
other money managers.
In addition U.S. based companies must adhere to the rigorous accounting and reporting
standards required in the U.S. by the IRS and the SEC.
ADRs
If one feels absolutely compelled to own companies headquartered in foreign countries,
ADRs (American Depository Receipts) are probably the best vehicle. The big advantage
is that they may be traded using U.S. dollars on a U.S. stock exchange. The U.S.
investor, through the ADR system, can choose among over 1,000 companies from about 40
countries. Companies from the UK, Japan, and Australia represent about 50% of all
ADRs traded.
The Mechanics of an ADR
A U.S. bank, the Bank of NY is a big player in ADRs, acts as custodian of the actual
shares of the foreign company. When these shares are received, the bank issues a
receipt, the ADR, which is backed by foreign shares in their custody.
For example one ADR for Honda Motors represents 2 shares of Honda stock traded in
Tokyo, or 1 ADR for Hong Kong Telephone represents 10 shares of Hong Kong Telephone stock
traded in Hong Kong.
We strongly recommend, however, investing in U.S. based companies.
This is a way to reduce large risks that are present in international investing while
getting exposure to some potentially large rewards. It's the best way to avoid the
bumpy ride on the international band wagon.
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