International Equity Exchange-Traded Funds

Navigating Global ETF Market Opportunities and Risks

Ewa Feder-Sempach, Adam Zaremba, Tomasz Miziołek

• Publisher: Palgrave Macmillan
• Year: 2020
• Print ISBN: 9783030538637
• eBook ISBN: 9783030538644
• Topic: Business
• Subtopic: Finance
• Index: Business

·       Provides a practical guide to investing in international ETFs as a way to gain exposure to foreign stock markets while comparatively analyzing ETFs as financial innovations in the international environment

·       Explores one specific market segment, offering the first in-depth and state-of-the-art analysis of international equity ETFs

·       Adds a new perspective by discussing a range of examples from developed and emerging economies.

Part IInternational Investments

© The Author(s) 2020

T. Miziołek et al.International Equity Exchange-Traded Fundshttps://doi.org/10.1007/978-3-030-53864-4_1

Begin Abstract

1. The Economics of the International Market

Tomasz Miziołek¹ , Ewa Feder-Sempach¹ and Adam Zaremba^{2, 3}

(1)

Department of International Finance and Investments, University of Lodz, Lodz, Poland

(2)

Montpellier Business School, Montpellier, France

(3)

Department of Investment and Financial Markets, Institute of Finance, Poznan University of Economics and Business, al. Niepodleglosci 10, Poznan, Poland

Ewa Feder-Sempach

Email: [email protected]

End Abstract

1.1 Introduction

International investing has exploded in popularity in recent years. There have been several major trends in global markets that have made foreign financial markets more welcome. The first one is growing global integration, which has created new opportunities both for investors and issuers who want to raise capital across national borders. The second one is the increasing importance of multinational financial corporations as facilitators of international investment products in host countries in different parts of the world. The third and final trend is the integration of the money and capital markets in European Union (EU) countries to remove market imperfections that impede the flow of international capital worldwide.

Every international investor should be aware of all the benefits and constraints that come from the international marketplace. Investing in an international financial market is not easy due to culture shock, which is mostly caused by different institutions, procedures, and traditions. However, many barriers to international investment exist besides the lack of knowledge investors may have, like psychological, political, or legal restrictions. The main aim of this chapter is to familiarize the reader with the international financial markets and the economic rules that could potentially help to achieve expected rates of return.

1.2 Foreign Investment Opportunities

International portfolio investments are an everyday practice for institutional investors all over the world. Many individual and institutional investors have more than half of their portfolio assets abroad. The mere size of foreign capital markets justifies international diversification, even for American or European investors. If the world’s capital market were fully efficient, buying internationally diversified portfolios would be a suitable behavior. However, we are aware that no fully integrated international capital market exists, even in the EU, and that some constraints may be present. International investments offer expected additional profit because investors may reduce portfolio risk, and risk-adjusted performance may be enhanced. Every domestic security tends to behave in the same way because it is affected by the country’s economic conditions—interest rates, money supply, unemployment, budget deficit, and GDP growth. This causes a strong positive correlation between the different equity types traded in one market and is why many investors have tried to diversify this risk using international financial markets.

International capital markets should be independent; otherwise, diversification opportunities would not exist. An example of the impression of the independence of international capital markets could be the performance of major stock indices from different parts of the world, from 1989 to 2019, and the correlation coefficients between them (see Fig. 1.1 and Table 1.1).

Fig. 1.1

Major stock markets indices, 1989–2019 (points)

(Source Thomson Reuters EIKON)

Table 1.1

Correlation matrix: major stock market indices between 1989 and 2019 (monthly logarithmic returns)

	S&P 500 USA	FTSE 100 UK	DAX DE	CAC 40 FR	TOPIX JP	HANG SENG CN
S&P 500 USA	1.00	0.77	0.73	0.73	0.50	0.61
FTSE 100 UK	0.77	1.00	0.74	0.79	0.46	0.59
DAX DE	0.73	0.74	1.00	0.87	0.48	0.54
CAC 40 FR	0.73	0.79	0.87	1.00	0.51	0.53
TOPIX JP	0.50	0.46	0.48	0.51	1.00	0.40
HANG SENG CN	0.61	0.59	0.54	0.53	0.40	1.00

Source Own calculations based on Thomson Reuters EIKON data

According to Table 1.1, the correlation coefficients between major international stock market returns in the last thirty-one years may have changed over the period, but still they are far from unity. The correlation between American and European stock returns is quite strong but when considering American or European and Asian stock returns it is much weaker. Interestingly, the correlation coefficient between the Japanese TOPIX and the Chinese HANG SENG is 0.40, and it is the lowest value. Not surprisingly, the strongest correlation coefficient is between the German DAX and the French CAC40, which is 0.87, and these countries are closely linked. This is caused by strong economic integration and collaboration. This table shows that international portfolio managers have many diversification opportunities throughout the different stock markets. Low correlation across different stock markets is the main idea of international portfolio diversification and global stock exposure. The results of many studies show that, compared to the domestic portfolio approach, international diversification has potential benefits.

The independence level of a country’s stock market is closely related to government policies and the independence of the economy. To some extent, global factors could influence national companies and their stock prices, but purely national factors seem to play a major role in asset pricing. In particular, it depends on the company’s size and level of internationalization. Constraints and legal regulations imposed by the government, fiscal and monetary policy, the stage of technological advancement, and cultural and sociological inequalities all contribute to the independence of the country’s stock market. By contrast, we should consider globalization processes and international economic integration, mostly in European countries. The harmonization of economic policy within the EU has had a considerable impact on the economies of member countries, and economic integration among euro area countries has important consequences for the factors driving asset returns in financial markets. Some recent research even showed that diversification over industries yields more efficient portfolios than diversification over Eurozone countries (Moerman 2004).

Many studies have been carried out to assess the level of international correlation coefficients between single-country stock markets at the European and American levels. One was conducted by Gilmore and McManus (2002), who compared the US stock market and three Central European markets. They revealed that US investors could obtain benefits from international diversification into these markets, apart from the Polish and Hungarian markets, in which stock returns were positively correlated.

There are also studies that tried to find leads or lags between single-country stock markets. The relationship between emerging and emerged markets was analyzed by Ullah and Ullah (2016), who stated that an emerging market’s volatility could be explained by an emerged market’s volatility. Thus, their overall results support the existence of a lead-lag relationship between selected emerging and emerged stock market indices. Another study was carried out by Wong et al. (2004), who used the concept of cointegration to investigate the existence of co-movement between stock markets in major developed countries and in Asian emerging economies. They found increasing interdependence between the majority of developed and emerging markets after the Stock Market Crash in 1987, and this interdependence intensified after the Asian Financial Crisis in 1997. Because this increasing co-movement between developed and emerging stock markets was observed, it could mean that the benefits of international diversification become smaller. However, no evidence of continued delayed¹ of one national stock market to another has been revealed so far.

In general, one can establish the following stylized facts regarding international stock return movements based on the work of Bekaert et al. (2005), who studied weekly portfolio returns from 23 developed markets:

• There is no evidence for an overall upward trend in return correlations, except for European stock market returns. They stressed that correlation coefficients are not the perfect measure, and they could rise because of changes in many financial determinants.
• They recognized that there was something like an excessive correlation period, which they referred to as the contagion effect. It means that correlations in times of crisis may be pr...

Table of contents

• Cover
• Front Matter
• Part I. International Investments
• Part II. Fundamentals of Exchange-Traded Funds
• Part III. International Equity Exchange-Traded Funds
• Part IV. Exchange-Traded Funds Investing: Strategies for International Markets
• Back Matter