International Financial Markets 9781846637759, 9781846637742

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ISSN 0307-4358

Volume 34 Number 1 2008

Managerial Finance International financial markets Guest Editor: Ajay Samant

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Managerial Finance

ISSN 0307-4358 Volume 34 Number 1 2008

International financial markets Guest Editor Ajay Samant

Access this journal online _________________________

2

Editorial advisory board___________________________

3

Guest editorial ___________________________________

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Risk-adjusted performance of international mutual funds Onur Arugaslan, Ed Edwards and Ajay Samant _____________________

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Why do firms issue global bonds? Oranee Tawatnuntachai and Devrim Yaman ________________________

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Privatisation in New Zealand and Australia: an empirical analysis Jarrod Kerr, Mei Qiu and Lawrence C. Rose ________________________

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Price and trading volume reactions to index constitution changes: the Australian evidence John Pinfold and Mei Qiu _______________________________________

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CONTENTS

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Editorial advisory board

EDITORIAL ADVISORY BOARD

Professor Kofi A. Amoateng NC Central University, Durham, USA

Professor Moses L. Pava Yeshiva University, New York, USA

Professor Felix Ayadi Jesse E. Jones School of Business, Texas Southern University, USA Professor Mohamed E. Bayou The University of Michigan-Dearborn, USA Dr Andre de Korvin University of Houston-Downtown, USA Dr Colin J. Dodds Saint Mary’s University, Halifax, Nova Scotia, Canada Professor John Doukas Old Dominion University, Norfolk, Virginia, USA

Professor George C. Philipatos The University of Tennessee, Knoxville, Tennessee, USA Professor David Rayome Northern Michigan University, USA Professor Alan Reinstein Wayne State University, Detroit, Michigan, USA Professor Ahmed Riahi-Belkaoui The University of Illinois at Chicago, USA Professor Mauricio Rodriguez Texas Christian University, Fort Worth, Texas, USA

Professor Uric Dufrene Indiana University Southeast, New Albany, Indiana, USA

Professor Salil K. Sarkar Henderson State University, Arkadelphia, Arkansas, USA

Professor Ali M. Fatemi De Paul University, Chicago, Illinois, USA

Professor Atul A. Saxena Mercer University, Georgia, USA

Professor Iftekhar Hasan New Jersey Institute of Technology, USA

Professor Philip H. Siegel Monmouth University, New Jersey, USA

Professor Suk H. Kim University of Detroit Mercy, Detroit, USA

Professor Kevin J. Sigler The University of North Carolina at Wilmington, USA

Professor John Leavins University of Houston-Downtown, USA Professor R. Charles Moyer Wake Forest University, Winston-Salem, North Carolina, USA

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Professor Gordon Wills International Management Centres, UK Professor Stephen A. Zeff Rice University, Texas, USA

Dr Khursheed Omer University of Houston-Downtown, USA

Managerial Finance Vol. 34 No. 1, 2008 p. 3 # Emerald Group Publishing Limited 0307-4358

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Managerial Finance Vol. 34 No. 1, 2008 p. 4 # Emerald Group Publishing Limited 0307-4358

Guest editorial Foreword The theme of this special issue is ‘‘International Financial Markets’’. The criterion used here for selection of articles is that the issues examined should be of current interest to financial managers, international investors, providers of global financial services, and should be relatively under-researched in business academia. At the risk of stating the obvious, it needs to be re-emphasized that most financial securities now trade in a global marketplace. Two prominent drivers of the process of globalization are financial de-regulation and advances in information technology. Although global investors can choose from a menu of financial securities that is unprecedented in its wide range of choice, the very same abundance makes the job of security selection more challenging now than it has ever been in the past. One of the objectives of this special issue is to provide a selection of research articles which would be of use to global investors as input in the evaluation of international investing opportunities. The first article evaluates the risk-adjusted performance of US-based international equity mutual funds using objective measures grounded in modern portfolio theory. This article utilizes a relatively new performance measure (developed by Modigliani and Modigliani in 1997) to report the risk-adjusted returns on these funds. It is evident from the results that some funds with high average returns look less attractive when the risk of the fund is factored into the analysis. Conversely, financial leverage can be used to raise the returns on international mutual funds with low risk. The second article examines the motivation for issuing global bonds. The relationship between the issue of global bonds and corporate reputation, firm size, issue size, and interest rate environment, is examined. The stock market reaction to issue of domestic bonds and global bonds is compared. This study provides information on both the issuance costs and signaling implications of global bonds. The third article evaluates the impact of New Zealand and Australian privatization programs on the growth and efficiency of their stock markets. In both countries, privatization resulted in significant growth in market capitalization, and, in the case of New Zealand, significant improvement in stock market liquidity. The article reports the comparison of the performance of the portfolio of privatized companies with a market portfolio, in each country. The issue of possible under-pricing of privatized company IPOs is also examined. Finally, the fourth article studies the impact on price and trading volume, of changes in the composition of Australian stock market indexes. The index effect has been well-documented in USA markets, and the authors examine whether a similar reaction is evident in Australian markets. This study has clear implications for investors looking at the possibility of market speculation based on index inclusion (or exclusion) in Australia. Ajay Samant Special Issue Editor, Western Michigan University (USA)

The current issue and full text archive of this journal is available at www.emeraldinsight.com/0307-4358.htm

Risk-adjusted performance of international mutual funds

Performance of international mutual funds

Onur Arugaslan, Ed Edwards, and Ajay Samant Haworth College of Business, Western Michigan University, Kalamazoo, Michigan, USA

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Abstract Purpose – This paper aims to evaluate the risk-adjusted performance of US-based international equity funds using objective statistical measures grounded in modern portfolio theory, and to present the results in a manner which is easily understood by the average investor. Design/methodology/approach – This study evaluates the performance of 50 large US-based international equity funds using risk-adjusted returns during 1994-2003. In particular, a relatively new risk-adjusted performance measure (M squared), first proposed by Franco Modigliani and Leah Modigliani in 1997, is used to evaluate these equity funds. Findings – The empirical results show that the funds with the highest average returns may lose their attractiveness to investors once the degree of risk embedded in the fund has been factored into the analysis. Conversely, some funds, whose average (unadjusted) returns do not stand out, may look very attractive once their low risk is factored into their performance. Research limitations/implications – It may be worthwhile to examine the effects of factors such as fund manager compensation, service fees, corporate governance metrics, and overweighting in risky countries/regions on the performance of international equity funds. Practical implications – The evidence presented in this study can be used as input in decision making by investors who are exploring the possibility of participating in the global stock market via international equity funds. Originality/value – This paper is one of the first studies that apply the new M squared measure to evaluate the performance of international equity funds using both domestic and international benchmark indices. Various other performance metrics are also utilized including Sharpe and Treynor measures, and Jensen’s Alpha. Keywords Performance measures, Unit trusts, Risk assessment, Diversification Paper type Research paper

Introduction Given the desire of investors to seek out diversification in their asset portfolios and considering the modest performance of the US equity markets since 2000, it is no surprise that many investors have sought to diversify their holdings further by investing in international equity funds. The growing US federal budget and trade balance deficits along with a weak dollar, high oil prices, concerns about inflation, and rising interest rates, give investors more reasons to shift some of their investments to non-US markets. Even though stock markets across the globe may face similar economic downturns, it is still possible to observe some stock markets, whether emerging or developed, to do better than others. In order to make informed decisions on which international equity funds to hold, investors would appreciate documentation on their risk-adjusted performance. This study evaluates the performance of 50 large USbased international equity funds using risk-adjusted returns during 1994-2003. In particular, a relatively new risk-adjusted performance measure, first proposed by Franco Modigliani and Leah Modigliani in 1997, is used to evaluate these equity funds. This paper builds on prior work in Samant and Edwards (2000) and Edwards and Samant (2003). Samant and Edwards (2000) study the performance of international mutual funds during the period 1990-1999. This study focuses on a different time

Managerial Finance Vol. 34 No. 1, 2008 pp. 5-22 # Emerald Group Publishing Limited 0307-4358 DOI 10.1108/03074350810838190

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period and also utilizes multiple benchmark indices to proxy the market portfolio. Edwards and Samant (2003), on the other hand, investigate the performance of socially responsible mutual funds in the US during 1991-2000. Some caveats of the study need to be mentioned, up front. First, all studies on the long-term performance of mutual funds are affected by ‘‘survivor bias’’, i.e. only those funds that have survived during the period under study, are included in the data. Second, past results cannot predict future performance. Finally, the results of this study are not intended to, and should not, be interpreted as investment advice. The rest of the paper is organized as follows. The next section summarizes the related literature on mutual fund performance. The following two sections describe the data and present the methodology. Next, the results of the five-year and ten-year performance analyses are reported. The final two sections discuss the results and conclude the paper. Review of the literature Evaluation of the performance of investment portfolios was pioneered by Treynor (1965), Sharpe (1966), and Jensen (1968). The statistical techniques developed by them are the most commonly used portfolio performance measures even now. Treynor (1965) suggested a way of evaluating the performance of a portfolio by adjusting the mean excess return (i.e. mean return less the risk-free rate of return in the economy) for the degree of market (systematic) risk and thus calculating the performance of the portfolio. Systematic risk could be estimated by regressing the mutual fund’s returns on the returns to a market benchmark index. Sharpe (1966) computed mean excess return and adjusted for the degree of total risk involved in the portfolio. Total risk was estimated by the standard deviation of returns. Jensen (1968) devised a method of determining whether the deviation of portfolio returns from market returns was statistically significant, and, therefore, determining whether the excess return could be attributed to superior management, or purely to chance. The techniques used in these three pioneering studies were further refined by Kon and Jen (1979), Henrikkson and Merton (1981), and Chang and Lewellen (1984). Kon and Jen (1979) developed a methodology to evaluate timing, selectivity, and market efficiency of mutual funds. Henrikkson and Merton (1981) developed statistical procedures to evaluate forecasting skills of managers. The study by Chang and Lewellen (1984) focused on the issue of market timing and the investment performance of mutual funds. Recent research has utilized non-market factors like size, bookto-market, momentum, number of securities, and turnover to assess mutual fund performance (Carhart, 1997; Daniel et al., 1997; Kothari and Warner, 2001). The performance of international mutual funds has been studied by Cumby and Glen (1990), Eun et al. (1991), and Droms and Walker (1994). In a recent study, Redman et al. (2000) compare the performance of various portfolios of international mutual funds with domestic benchmarks. Bailey et al. (2005), on the other hand, study the impact of political risk on the risk-adjusted returns of international mutual funds. In 1997, Nobel Laureate Franco Modigliani and Leah Modigliani, his granddaughter, did some pioneering work in the area of financial reward and risk. They proposed a new risk-adjusted performance measure (hereafter referred to as, M squared), which is intuitively quite appealing to investors. The idea that underlies their methodology is to adjust the returns of a mutual fund to the level of risk in an unmanaged stock market index and then measure the returns on the risk-matched fund. This method has two distinct advantages over earlier techniques. First, it reports the risk-adjusted

performance of a mutual fund as a per centage, which is easily understood by a lay investor. Second, the method permits investors to calculate the degree of leverage that is needed to attain the highest return possible for a given level of risk. On the one hand, aggressive investors can use this information to raise their expected returns by levering their portfolio (borrowing money and investing in the right mutual fund). On the other hand, risk-averse investors can use this information to reduce their expected risk by unlevering their portfolio (selling off part of their holding in a mutual fund and investing the proceeds in a risk-free security, such as a Treasury bill). Practitioner literature (for example, Morningstar, 2004) often contains reports on the mean returns to international mutual funds. However, the only measure of risk that is usually reported is the standard deviation of fund returns. Risk-adjusted returns are almost never reported and the reader is given very little guidance as to what criteria to employ while choosing a mutual fund from among a menu of several funds with attractive returns and widely different levels of risk. The objective of this study is to narrow the gap between practitioner-oriented literature and academic literature on the subject of evaluating the risk-adjusted returns on international mutual funds. While the former is not well grounded in terms of investment management theory, the latter is often unintelligible to the average investor, as it uses technical jargon and abstract mathematical principles. The contribution of this study is that it evaluates, in a rigorous manner, the performance of international mutual funds using performance measures that are easily understood by the average investor, such as simple per centages that report the risk-adjusted returns that accrued to these mutual funds. As mentioned before, the study makes extensive use of the M squared measure and is one of the first studies to apply this measure to evaluate the performance of international mutual funds. Data Seventy-two US-based international mutual funds are obtained using the Morningstar (2004) edition. These funds usually have more than 50 per cent of their assets invested outside US equity markets. Quarterly returns for these funds for the five-year period 1999-2003 are gathered from the same edition of Morningstar, for five-year performance analysis. Of these 72 funds, 60 have complete returns data for 20 quarters. One fund is eliminated since its Morningstar category is specialty-precious metals. The largest 50 of the remaining funds are selected on the basis of total assets as of 31 December, 2003. Quarterly returns for the five-year period 1994-1998 are gathered from Morningstar (1999) edition, for ten-year performance analysis. Of the 50 funds studied in the five-year analysis, 22 funds were in existence in 1994. The quarterly return data for the 90-day US Treasury bills, the Morgan Stanley Capital International (MSCI) Europe, Australasia, and Far East (EAFE) index, and the Standard and Poor’s 500 (S&P500) index are collected from the 2004 and previous editions of the Morningstar Funds 500. Methodology This study estimates risk-return profiles for international mutual funds that have been around for the five-year period 1999-2003 and also for those that have been around for the ten-year period 1994-2003. Quarterly returns are used for computing measures of return and risk. Thus, each statistic reported for the five-year period 1999-2003 is based on at least 20 distinct data points and each statistic reported for the ten-year period 1994-2003 is based on at least 40 distinct data points.

Performance of international mutual funds 7

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Mean returns are calculated by averaging the quarterly returns over the relevant time period. Mean excess return is calculated by subtracting the risk-free rate of return from the mean return. The proxy used in this study for the risk-free rate of return is the average yield on 90-day US Treasury bills. This is in accordance with the standard practice in performance evaluation of mutual funds. Total risk is measured by the standard deviation of returns. Systematic (market) risk is estimated by beta, which is calculated as the slope coefficient in the regression of the fund rate of return on the market rate of return. In order to make the results of this study easily comparable to results published in practitioner literature, the market benchmarks used here are the MSCI EAFE index and the S&P500 index. The Sharpe performance measure is calculated for each fund by dividing the mean excess return by the total risk of the fund, as estimated by its standard deviation of returns: Si ¼

Ri
Rf i

where Ri, mean return on fund i; Rf, mean risk-free rate of return; i, standard deviation of returns for fund i. The Treynor performance measure is calculated by dividing the mean excess return of each fund by its beta: Ti ¼

Ri
Rf i

where i is obtained from the market model: Rit ¼ i þ i Rmt þ eit where Rmt, return on the market index during period t ; eit, stochastic error term. Jensen’s Alpha is calculated by subtracting the expected return of each fund from its actual mean return: i ¼ Ri
ðRf þ i ðRm
Rf ÞÞ The expected return for each fund is calculated using the Capital Asset Pricing Model. Jensen’s Alphas are then tested for statistical significance. The M squared measure is computed by multiplying the Sharpe measure by the benchmark standard deviation and then adding the risk-free rate of return: M 2i ¼

Ri
Rf  m þ Rf i

Finally, the leverage factor is calculated by dividing the market standard deviation by the fund standard deviation: Li ¼

m i

A leverage factor greater than one implies that the standard deviation of the fund is less than the standard deviation of the market index, and that the investor should consider levering the fund by borrowing money (if possible, at the risk-free rate of return) and investing in that particular fund. While this would tend to increase the risk of the investment somewhat, there would be a greater than proportional increase in returns. A leverage factor less than one implies that the risk of the fund is greater than the risk of the market index, and that the investor should consider unlevering the fund by selling off part of the holding in the fund and investing the proceeds in a risk-free security, such as a Treasury bill. In this way, while the returns on the investment reduce somewhat, there would be a greater than proportional reduction in the risk. Results of the study Five-year performance The 50 largest international equity funds with full quarterly return data are identified in Table I with benchmark EAFE index and in Table II with benchmark S&P500 index along with their risk, return, and performance statistics. The funds are ranked in descending order according to their total assets as of 31 December, 2003. The largest of these funds is American Funds EuroPacific Growth with total assets of approximately $33.8 billion. The fund with the highest mean return is Oppenheimer Developing Markets with an average quarterly return of 6.2 per cent. In comparison, the quarterly mean return of the benchmark EAFE index is 0.4 per cent and the quarterly mean return of the benchmark S&P500 index is 0.3 per cent. The fund with the highest total risk (measured by the standard deviation of returns) is T. Rowe Price International Discovery with a quarterly standard deviation of 19.0 per cent. Again, in comparison, the standard deviation of the benchmark EAFE index is 10.5 per cent and the standard deviation of the benchmark S&P500 index is 9.9 per cent. Further, Tables I and II report the numerical values of the Sharpe measures, which are used to rank the funds in Tables III and IV. The highest Sharpe measure obtained (0.54) is by First Eagle Global. In comparison, the Sharpe measure of the benchmark EAFE index is
0.04 and the Sharpe measure of the benchmark S&P500 index is
0.05. Table I also reports the values of fund Betas, M squared measures, Jensen’s Alphas (and their t-statistics), and Treynor measures, all of which are computed using the benchmark EAFE index. The fund with the highest systematic risk (Beta ¼ 1.47) is Oppenheimer Global Opportunities. In comparison, the Beta of the benchmark EAFE index is, by definition, exactly 1.0. The fund with the highest M squared measure (6.51) is First Eagle Global. In comparison, the benchmark EAFE index had an M squared measure of 0.44. The fund with the highest Alpha measure is Oppenheimer Developing Markets with Alpha equal to 5.93. The Alpha measure of the benchmark EAFE index is, by definition, zero. None of the fund Alphas is significantly different from zero. Finally, the fund with the highest Treynor measure (6.63) is First Eagle Global. In comparison, the Treynor measure for the EAFE index is
0.43. Table II reports the values of fund Betas, M squared measures, Jensen’s Alphas (and their t-statistics), and Treynor measures, all of which are computed using the S&P500 index. The fund with the highest systematic risk (Beta ¼ 1.57) is Oppenheimer Global Opportunities. In comparison, the Beta of the benchmark S&P500 index is, by definition, exactly 1.0. The fund with the highest M squared measure (6.19) is First Eagle Global. In comparison, the benchmark S&P500 index had an M squared measure of 0.33. The fund with the highest Alpha measure is Oppenheimer Developing Markets

Performance of international mutual funds 9

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Table I. Five-year performance on a quarterly basis using the MSCI index as benchmark (1999-2003)

Stock mutual funds 1. Amer Funds EuroPac A 2. Amer Funds New Persp A 3. Amer Funds CplncBldr A 4. Templeton Growth A 5. Amer Funds CapWrldGI A 6. Templeton Foreign A 7. Fidelity Diversified Int 8. Putnam Intl Equity A 9. Janus Worldwide 10. Artisan International 11. Oppenheimer Glob A 12. Vanguard Intl Gr 13. Vanguard Eur Stk Idx 14. Templeton World A 15. Merrill Global Alloc A 16. Morgan Stan Ins IntlEq A 17. Harbor Intl Instl 18. First Eagle Overseas A 19. First Eagle Glbl A 20. Vanguard Total Intl Stk 21. T. Rowe Price Intl Stk 22. Mutual Discovery A 23. Tweedy, Browne Glob Val 24. Bernstein Tx-Mgd Intl 25. Julius Baer Intl Eqty A 26. Fidelity Overseas 27. Oakmark International I 28. AmCent Intl Growth Inv 29. Janus Overseas 30. Oppenheimer Glob Oppor A 31. Templeton Devel Mkts A 32. William Blair Intl Gr N 33. Vanguard Em Mkt Idx 34. Vanguard Intl Value 35. Columbia Acorn Intl Z 36. Longleaf Partners Intl 37. AmCent Intl Disc Inv 38. Mutual European A 39. Oppenheimer Develop MktA 40. Fidelity Worldwide 41. Dreyfus Prem Emerg A 42. Vanguard Global Equity 43. Masters’ Select Intl 44. T. Rowe Price New Asia 45. Oakmark Intl Small Cap I 46. UMB Scout WorldWide 47. Vanguard Intl Explorer 48. MFS Global Total Retrn A 49. T. Rowe Price Intl Disc 50. Fidelity Pacific Basin Benchmarks MSCI EAFE US 90-day Treasury/bill

EAFE Assets AVG STD Sharpe M Alpha ($ million) (%) (%) measure Beta squared Alpha t-stat* Treynor 33,798 30,630 23,525 17,038 16,744 14,028 13,559 12,451 10,965 9,322 9,113 7,639 7,484 7,456 6,728 6,369 6,284 4,935 4,860 4,786 4,597 4,466 4,189 4,108 4,100 3,961 3,691 3,195 2,724 2,457 2,316 1,896 1,846 1,704 1,680 1,488 1,233 1,120 1,092 957 899 744 732 662 598 593 500 491 483 430

1.9 2.2 1.8 2.8 2.7 2.4 2.7 1.8 0.8 2.9 3.3 0.8 0.5 1.9 3.2 2.3 2.1 4.6 4.2 0.8 0.3 2.9 2.3 1.8 3.6 1.1 4.0 1.1 2.4 4.1 3.0 4.1 3.6 1.4 2.7 4.2 3.8 3.7 6.2 1.7 5.1 3.0 3.4 4.2 5.0 1.3 4.4 1.2 5.7 2.9

11.6 11.0 4.7 9.1 8.8 9.7 11.1 12.6 14.8 16.1 13.8 11.1 11.5 9.9 7.6 8.4 10.6 7.1 6.2 10.7 11.8 7.2 8.2 10.1 14.3 12.3 13.0 14.5 18.5 17.2 14.0 13.9 15.1 10.8 15.3 10.5 16.7 9.4 16.3 10.7 14.4 9.4 14.6 17.8 12.9 9.0 14.9 4.8 19.0 14.9

0.09 0.12 0.20 0.21 0.21 0.16 0.17 0.08 0.00 0.13 0.18
0.01
0.03 0.10 0.30 0.17 0.12 0.53 0.54
0.01
0.05 0.29 0.17 0.09 0.19 0.02 0.24 0.01 0.08 0.19 0.15 0.23 0.18 0.05 0.12 0.31 0.18 0.30 0.33 0.08 0.29 0.22 0.17 0.19 0.32 0.05 0.24 0.07 0.25 0.14

1.05 1.00 0.28 0.77 0.80 0.82 1.02 1.12 1.20 1.33 1.18 1.03 1.07 0.88 0.60 0.71 0.97 0.59 0.50 1.02 1.11 0.57 0.59 0.90 1.14 1.15 0.99 1.19 1.46 1.47 1.07 1.18 1.24 0.95 1.29 0.62 1.25 0.77 1.38 0.96 1.09 0.82 1.27 1.40 0.94 0.84 1.20 0.43 1.46 1.14

1.84 2.09 2.97 3.06 3.04 2.53 2.63 1.67 0.84 2.20 2.70 0.77 0.52 1.94 4.04 2.64 2.09 6.38 6.51 0.76 0.38 3.87 2.67 1.83 2.87 1.07 3.41 1.01 1.72 2.85 2.46 3.26 2.77 1.43 2.16 4.14 2.71 4.05 4.28 1.71 3.95 3.20 2.70 2.83 4.22 1.39 3.36 1.61 3.51 2.29

1.53 0.43 1.72 0.50 1.07 0.53 2.25 0.76 2.17 0.74 1.88 0.62 2.31 0.68 1.45 0.38 0.48 0.10 2.62 0.58 2.92 0.74 0.34 0.10 0.08 0.01 1.39 0.45 2.56 0.94 1.72 0.61 1.65 0.50 4.01 1.48 3.53 1.38 0.33 0.10
0.07
0.03 2.31 0.88 1.68 0.62 1.31 0.42 3.22 0.80 0.74 0.19 3.59 0.96 0.71 0.16 2.14 0.41 3.88 0.82 2.59 0.65 3.69 0.93 3.28 0.77 0.99 0.30 2.44 0.56 3.55 1.12 3.47 0.76 3.19 1.05 5.93 1.33 1.28 0.39 4.69 1.17 2.45 0.80 3.10 0.74 3.95 0.82 4.54 1.23 0.81 0.29 4.07 0.98 0.53 0.30 5.42 1.08 2.52 0.60

0.4 10.5
0.04 1.00 0.9 0.5 0.00
0.01

0.44 0.86

0.00
0.01

Note: *None of the t-statistics is significant at the 5 per cent level

1.03 1.29 3.32 2.50 2.30 1.87 1.84 0.86
0.03 1.54 2.05
0.10
0.36 1.16 3.80 1.99 1.27 6.40 6.63
0.10
0.49 3.64 2.40 1.03 2.39 0.21 3.18 0.16 1.04 2.21 1.99 2.71 2.22 0.61 1.47 5.33 2.34 3.74 3.85 0.90 3.88 2.58 2.02 2.38 4.38 0.54 2.96 0.80 3.29 1.78

0.00
0.43 0.18 0.00

Stock mutual funds 1. Amer Funds EuroPac A 2. Amer Funds New Persp A 3. Amer Funds CplncBldr A 4. Templeton Growth A 5. Amer Funds CapWrldGI A 6. Templeton Foreign A 7. Fidelity Diversified Int 8. Putnam Intl Equity A 9. Janus Worldwide 10. Artisan International 11. Oppenheimer Glob A 12. Vanguard Intl Gr 13. Vanguard Eur Stk Idx 14. Templeton World A 15. Merrill Global Alloc A 16. Morgan Stan Ins IntlEq A 17. Harbor Intl Instl 18. First Eagle Overseas A 19. First Eagle Glbl A 20. Vanguard Total Intl Stk 21. T. Rowe Price Intl Stk 22. Mutual Discovery A 23. Tweedy, Browne Glob Val 24. Bernstein Tx-Mgd Intl 25. Julius Baer Intl Eqty A 26. Fidelity Overseas 27. Oakmark International I 28. AmCent Intl Growth Inv 29. Janus Overseas 30. Oppenheimer Glob Oppor A 31. Templeton Devel Mkts A 32. William Blair Intl Gr N 33. Vanguard Em Mkt Idx 34. Vanguard Intl Value 35. Columbia Acorn Intl Z 36. Longleaf Partners Intl 37. AmCent Intl Disc Inv 38. Mutual European A 39. Oppenheimer Develop MktA 40. Fidelity Worldwide 41. Dreyfus Prem Emerg A 42. Vanguard Global Equity 43. Masters’ Select Intl 44. T. Rowe Price New Asia 45. Oakmark Intl Small Cap I 46. UMB Scout WorldWide 47. Vanguard Intl Explorer 48. MFS Global Total Retrn A 49. T. Rowe Price Intl Disc 50. Fidelity Pacific Basin Benchmarks S&P500 US 90-day Treasury bill

S&P500 Assets AVG STD Sharpe MAlpha ($ million) (%) (%) measure Beta squared Alpha t-stat* Treynor 33,798 30,630 23,525 17,038 16,744 14,028 13,559 12,451 10,965 9,322 9,113 7,639 7,484 7,456 6,728 6,369 6,284 4,935 4,860 4,786 4,597 4,466 4,189 4,108 4,100 3,961 3,691 3,195 2,724 2,457 2,316 1,896 1,846 1,704 1,680 1,488 1,233 1,120 1,092 957 899 744 732 662 598 593 500 491 483 430

1.9 2.2 1.8 2.8 2.7 2.4 2.7 1.8 0.8 2.9 3.3 0.8 0.5 1.9 3.2 2.3 2.1 4.6 4.2 0.8 0.3 2.9 2.3 1.8 3.6 1.1 4.0 1.1 2.4 4.1 3.0 4.1 3.6 1.4 2.7 4.2 3.8 3.7 6.2 1.7 5.1 3.0 3.4 4.2 5.0 1.3 4.4 1.2 5.7 2.9 0.3 0.9

11.6 11.0 4.7 9.1 8.8 9.7 11.1 12.6 14.8 16.1 13.8 11.1 11.5 9.9 7.6 8.4 10.6 7.1 6.2 10.7 11.8 7.2 8.2 10.1 14.3 12.3 13.0 14.5 18.5 17.2 14.0 13.9 15.1 10.8 15.3 10.5 16.7 9.4 16.3 10.7 14.4 9.4 14.6 17.8 12.9 9.0 14.9 4.8 19.0 14.9 9.9 0.5

0.09 0.12 0.20 0.21 0.21 0.16 0.17 0.08 0.00 0.13 0.18
0.01
0.03 0.10 0.30 0.17 0.12 0.53 0.54
0.01
0.05 0.29 0.17 0.09 0.19 0.02 0.24 0.01 0.08 0.19 0.15 0.23 0.18 0.05 0.12 0.31 0.18 0.30 0.33 0.08 0.29 0.22 0.17 0.19 0.32 0.05 0.24 0.07 0.25 0.14
0.05 0.00

Note: *None of the t-statistics is significant at the 5% level

1.03 1.06 0.32 0.80 0.83 0.82 0.96 1.09 1.32 1.29 1.27 1.00 1.00 0.93 0.69 0.60 0.93 0.58 0.51 0.96 1.07 0.65 0.69 0.86 1.06 1.09 1.11 1.13 1.51 1.57 1.20 1.18 1.40 0.89 1.27 0.67 1.32 0.78 1.47 1.03 1.25 0.84 1.28 1.45 0.96 0.86 1.21 0.40 1.42 1.06 1.00
0.01

1.78 2.02 2.85 2.94 2.91 2.43 2.54 1.62 0.84 2.12 2.60 0.77 0.54 1.88 3.86 2.54 2.02 6.08 6.19 0.77 0.41 3.70 2.57 1.77 2.76 1.06 3.27 1.00 1.68 2.74 2.37 3.13 2.67 1.39 2.09 3.95 2.61 3.88 4.09 1.66 3.77 3.07 2.59 2.72 4.04 1.36 3.22 1.57 3.36 2.21 0.33 0.86

1.63 1.85 1.11 2.35 2.27 1.97 2.39 1.55 0.67 2.73 3.09 0.43 0.15 1.52 2.67 1.74 1.73 4.07 3.59 0.41 0.03 2.41 1.79 1.39 3.30 0.83 3.76 0.80 2.32 4.09 2.77 3.82 3.49 1.05 2.56 3.65 3.64 3.28 6.12 1.41 4.88 2.55 3.24 4.12 4.65 0.91 4.20 0.56 5.55 2.59 0.00 0.00

0.47 0.55 0.60 0.81 0.80 0.67 0.72 0.42 0.12 0.61 0.78 0.13 0.04 0.49 1.02 0.67 0.55 1.57 1.48 0.13 0.00 0.95 0.68 0.46 0.84 0.22 1.01 0.19 0.44 0.85 0.70 0.97 0.81 0.34 0.59 1.18 0.80 1.11 1.37 0.43 1.22 0.86 0.78 0.85 1.28 0.33 1.02 0.36 1.11 0.64 0.00 0.24

1.05 1.22 2.99 2.40 2.20 1.87 1.95 0.88
0.03 1.59 1.91
0.10
0.38 1.09 3.33 2.34 1.32 6.46 6.55
0.11
0.51 3.19 2.07 1.08 2.58 0.22 2.85 0.17 1.00 2.07 1.77 2.71 1.96 0.65 1.49 4.89 2.22 3.67 3.64 0.84 3.38 2.50 2.00 2.30 4.30 0.53 2.93 0.87 3.36 1.92
0.53 0.00

Performance of international mutual funds 11

Table II. Five-year performance on a quarterly basis using the S&P500 index as benchmark (1999-2003)

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Table III. Five-year ranking using the MSCI index as benchmark (1999-2003)

Stock mutual funds First Eagle Glbl A First Eagle Overseas A Oppenheimer Develop MktA Oakmark Intl Small Cap I Longleaf Partners Intl Mutual European A Merrill Global Alloc A Dreyfus Prem Emerg A Mutual Discovery A T. Rowe Price Intl Disc Oakmark International I Vanguard Intl Explorer William Blair Intl Gr N Vanguard Global Equity Templeton Growth A Amer Funds CapWrldGI A Amer Funds CplncBldr A Julius Baer Intl Eqty A Oppenheimer Glob Oppor A T. Rowe Price New Asia Vanguard Em Mkt Idx AmCent Intl Disc Inv Oppenheimer Glob A Masters’ Select Intl Tweedy, Browne Glob Val Morgan Stan Ins IntlEq A Fidelity Diversified Int Templeton Foreign A Templeton Devel Mkts A Fidelity Pacific Basin Artisan International Columbia Acorn Intl Z Harbor Intl Instl Amer Funds New Persp A Templeton World A Amer Funds EuroPac A Bernstein Tx-Mgd Intl Janus Overseas Fidelity Worldwide Putnam Intl Equity A MFS Global Total Retrn A Vanguard Intl Value UMB Scout WorldWide Fidelity Overseas AmCent Intl Growth Inv Janus Worldwide Vanguard Intl Gr Vanguard Total Intl Stk Vanguard Eur Stk Idx MSCI EAFE T. Rowe Price Intl Stk

Sharpe rank (M squared rank)

Treynor rank

Alpha rank

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51

1 2 6 4 3 8 7 5 9 11 12 13 14 15 16 21 10 18 23 19 22 20 24 25 17 26 29 28 27 30 31 32 34 33 35 38 37 36 39 40 41 42 43 44 45 46 47 48 49 50 51

12 6 1 4 11 16 21 3 26 2 10 5 9 23 27 28 40 15 8 7 14 13 18 17 33 31 25 30 20 22 19 24 34 32 37 35 38 29 39 36 45 41 42 43 44 46 47 48 49 50 51

Stock mutual funds First Eagle Glbl A First Eagle Overseas A Oppenheimer Develop MktA Oakmark Intl Small Cap I Longleaf Partners Intl Mutual European A Merrill Global Alloc A Dreyfus Prem Emerg A Mutual Discovery A T. Rowe Price Intl Disc Oakmark International I Vanguard Intl Explorer William Blair Intl Gr N Vanguard Global Equity Templeton Growth A Amer Funds CapWrldGI A Amer Funds CplncBldr A Julius Baer Intl Eqty A Oppenheimer Glob Oppor A T. Rowe Price New Asia Vanguard Em Mkt Idx AmCent Intl Disc Inv Oppenheimer Glob A Masters’ Select Intl Tweedy, Browne Glob Val Morgan Stan Ins IntlEq A Fidelity Diversified Int Templeton Foreign A Templeton Devel Mkts A Fidelity Pacific Basin Artisan International Columbia Acorn Intl Z Harbor Intl Instl Amer Funds New Persp A Templeton World A Amer Funds EuroPac A Bernstein Tx-Mgd Intl Janus Overseas Fidelity Worldwide Putnam Intl Equity A MFS Global Total Retrn A Vanguard Intl Value UMB Scout WorldWide Fidelity Overseas AmCent Intl Growth Inv Janus Worldwide Vanguard Intl Gr Vanguard Total Intl Stk Vanguard Eur Stk Idx T. Rowe Price Intl Stk S&P500

Sharpe rank (M squared rank)

Treynor rank

Alpha rank

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51

1 2 6 4 3 5 9 7 10 8 13 12 14 16 17 21 11 15 22 19 25 20 28 24 23 18 26 29 30 27 31 32 33 34 35 37 36 38 41 39 40 42 43 44 45 46 47 48 49 50 51

13 8 1 4 11 16 21 3 25 2 10 5 9 24 27 29 40 15 7 6 14 12 18 17 32 33 26 30 19 22 20 23 34 31 37 35 39 28 38 36 46 41 42 43 44 45 47 48 49 50 51

Performance of international mutual funds 13

Table IV. Five-year ranking using the S&P500 index as benchmark (1999-2003)

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with Alpha equal to 6.12. The Alpha measure of the benchmark S&P500 index is, by definition, zero. None of the fund Alphas is significantly different from zero. Finally, the fund with the highest Treynor measure (6.55) is First Eagle Global. In comparison, the Treynor measure for the S&P500 index is
0.53. Tables III and IV report the rankings of all the funds. The Sharpe, Treynor, and Alpha ranks in Table III all indicate that 49 funds had returns (adjusted for risk) that exceeded the risk-adjusted returns of the EAFE index. The only fund that underperforms the EAFE index is T. Rowe Price International Stock. The Sharpe, Treynor, and Alpha ranks in Table IV all indicate that all 50 funds had returns (adjusted for total risk) that exceeded the risk-adjusted returns of the S&P500 index. For both indices First Eagle Global has the highest Sharpe and Treynor ranks whereas Oppenheimer Developing Markets has the highest Alpha rank. The ranking on the basis of the M squared measure is identical to the ranking on the basis of the Sharpe measure. However, the M squared measure enables us to draw some inferences, which cannot be drawn from the Sharpe measure (or, as a matter of fact, from any other measure), and these are detailed at the end of this section. Table V reports the average returns that accrue to the funds with and without riskadjustment. The risk-adjustment is performed by using only the MSCI EAFE index as the benchmark. The returns are annualized for the convenience of investors. This is done by compounding the quarterly mean returns over four periods. Oppenheimer Developing Markets, which ranks first on the basis of mean (unadjusted) returns, falls back to rank three on the basis of returns adjusted for risk. On the other hand, First Eagle Global, which ranks eighth on an unadjusted basis, ranks first when the returns are adjusted for risk. The leverage factor for this fund is 1.70, which implies that an investor who is comfortable with bearing the same level of risk as in the benchmark EAFE index, could lever the fund (borrow 70 per cent of his/her down payment, if possible, at the risk-free rate of interest and invest in the fund) and thereby attain an annual return level of 28.67 per cent. The example below details how this return can be obtained. Consider an investor who would like to earn superior returns on an international mutual fund and, at the same time, bear only an average level of risk. In this context, the average level of risk is measured by the standard deviation of the benchmark EAFE index, which is 10.5 per cent on a quarterly basis. Now consider the following investment strategy: suppose that the investor has $1,000 to invest. The investor could borrow an additional $700 and invest a total of $1,700 in First Eagle Global. The end of quarter gross return on this portfolio will be $1,700  0.042 ¼ $71.40. Suppose that the borrowed funds were contracted at the quarterly risk-free rate of 0.9 per cent. In that case, the cost of borrowed funds is $700  0.009 ¼ $6.30. The portfolio return, net of interest cost, is $71.40
6.30 ¼ $65.10, which is a return of 6.51 per cent on a quarterly basis or 28.69 per cent (28.67 per cent in Table V due to rounding differences) on an annual basis. Note that the quarterly risk of the portfolio is 1.70  6.2 ¼ 10.5 per cent, which is the same as the quarterly standard deviation of the benchmark EAFE index. This investment strategy, therefore, enables the investor to earn superior returns for an average level of risk. It may be noted that the above example assumes that the covariance between the returns on a risk-free asset and the mutual fund is zero. An investor, who is comfortable with a higher level of risk, could have attained higher returns by levering the fund even further. What is interesting is that, no matter what level of risk the investor is comfortable with, she will be better off levering this particular mutual fund

Stock mutual funds First Eagle Glbl A First Eagle Overseas A Oppenheimer Develop MktA Oakmark Intl Small Cap I Longleaf Partners Intl Mutual European A Merrill Global Alloc A Dreyfus Prem Emerg A Mutual Discovery A T. Rowe Price Intl Disc Oakmark International I Vanguard Intl Explorer William Blair Intl Gr N Vanguard Global Equity Templeton Growth A Amer Funds CapWrldGI A Amer Funds CplncBldr A Julius Baer Intl Eqty A Oppenheimer Glob Oppor A T. Rowe Price New Asia Vanguard Em Mkt Idx AmCent Intl Disc Inv Oppenheimer Glob A Masters’ Select Intl Tweedy, Browne Glob Val Morgan Stan Ins IntlEq A Fidelity Diversified Int Templeton Foreign A Templeton Devel Mkts A Fidelity Pacific Basin Artisan International Columbia Acorn Intl Z Harbor Intl Instl Amer Funds New Persp A Templeton World A Amer Funds EuroPac A Bernstein Tx-Mgd Intl Janus Overseas Fidelity Worldwide Putnam Intl Equity A MFS Global Total Retrn A Vanguard Intl Value UMB Scout WorldWide Fidelity Overseas AmCent Intl Growth Inv Janus Worldwide Vanguard Intl Gr Vanguard Total Intl Stk Vanguard Eur Stk Idx MSCI EAFE T. Rowe Price Intl Stk

Unadjusted annualized returns (%)

Unadjusted rank

Adjusted annualized returns (%)

Adjusted rank

Leverage factor

17.80 19.81 27.20 21.54 17.68 15.78 13.26 21.94 12.25 24.61 17.12 18.87 17.23 12.40 11.61 11.21 7.43 15.19 17.51 17.93 15.25 16.09 13.78 14.41 9.46 9.43 11.43 9.93 12.54 12.10 12.17 11.46 8.67 8.89 7.75 8.01 7.36 9.85 7.10 7.53 4.93 5.90 5.38 4.50 4.31 3.36 3.09 3.06 1.95 1.75 1.29

8 5 1 4 9 14 19 3 22 2 12 6 11 21 25 28 38 16 10 7 15 13 18 17 31 32 27 29 20 24 23 26 34 33 36 35 39 30 40 37 43 41 42 44 45 46 47 48 49 50 51

28.67 28.08 18.27 17.99 17.60 17.23 17.17 16.74 16.40 14.80 14.35 14.11 13.71 13.44 12.83 12.70 12.41 11.99 11.90 11.80 11.57 11.29 11.26 11.23 11.12 10.96 10.96 10.49 10.21 9.49 9.09 8.91 8.62 8.61 7.98 7.56 7.51 7.07 7.03 6.84 6.60 5.82 5.68 4.35 4.08 3.40 3.11 3.07 2.09 1.75 1.53

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51

1.70 1.47 0.64 0.81 0.99 1.11 1.38 0.73 1.45 0.55 0.80 0.70 0.75 1.11 1.15 1.19 2.23 0.73 0.61 0.59 0.70 0.63 0.76 0.72 1.27 1.25 0.94 1.08 0.75 0.70 0.65 0.69 0.99 0.95 1.05 0.90 1.04 0.57 0.98 0.83 2.16 0.97 1.16 0.85 0.72 0.71 0.94 0.98 0.91 1.00 0.89

Performance of international mutual funds 15

Table V. Five-year annualized performance: unadjusted and adjusted for risk

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rather than any other fund. Thus, the methodology developed by Modigliani and Modigliani (1997) enables the investor to compute the optimal degree of leverage (or, equivalently, the amount of dollars to borrow) to attain any desired level of return. It is worth noting the improvement of American Funds Capital Income Builder from an unadjusted rank of 38 to an adjusted rank of 17. This is due to the fact that it has the lowest quarterly standard deviation of 4.7 sper cent, which translates into the highest leverage factor of 2.23. Finally, it may also be noted that the funds (and the benchmark EAFE index itself), which are ranked the lowest (ranks 44 through 51) on an unadjusted basis, are at the same lowest ranks on a risk-adjusted basis. Ten-year performance Data on quarterly returns over the ten-year period 1994-2003 are available for 22 of these funds. The funds are identified in Table VI with benchmark EAFE index and in Table VII with benchmark S&P500 index along with their risk, return, and performance statistics. The funds are ranked in descending order according to their total assets as of 31 December, 2003. The largest of these funds is, of course, American Funds EuroPacific Growth with total assets of approximately $33.8 billion. The funds with the highest mean returns are American Funds Capital World Growth and Income, Oppenheimer Global, and First Eagle Overseas with average quarterly returns of 3.3

Stock mutual funds 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. Table VI. Ten-year performance on a quarterly basis using the MSCI index as Benchmark (1994-2003)

Amer Funds EuroPac A Amer Funds New Persp A Amer Funds CplncBldr A Templeton Growth A Amer Funds CapWrldGI A Templeton Foreign A Fidelity Diversified Int Putnam Intl Equity A Janus Worldwide Oppenheimer Glob A Vanguard Intl Gr Vanguard Eur Stk Idx Harbor Intl Instl First Eagle Overseas A First Eagle Glbl A T. Rowe Price Intl Stk Tweedy, Browne Glob Val Oakmark International I AmCent Intl Growth Inv Templeton Devel Mkts A Columbia Acorn Intl Z Fidelity Worldwide

Benchmarks MSCI EAFE US 90-day Treasury bill

EAFE Assets AVG STD Sharpe M Alpha ($ million) (%) (%) measure Beta squared Alpha t-stat* Treynor 33,798 30,630 23,525 17,038 16,744 14,028 13,559 12,451 10,965 9,113 7,639 7,484 6,284 4,935 4,860 4,597 4,189 3,691 3,195 2,316 1,680 957

2.4 3.1 2.7 2.8 3.3 2.0 3.0 2.7 2.8 3.3 1.7 2.6 2.8 3.3 3.1 1.4 2.9 2.7 2.1 1.4 2.5 2.2

9.5 9.1 4.5 7.9 7.4 8.3 9.0 10.6 11.9 11.0 9.3 9.7 9.1 6.5 5.5 9.7 7.8 11.4 11.6 13.0 11.9 9.3

0.15 0.23 0.36 0.22 0.30 0.12 0.22 0.15 0.15 0.20 0.07 0.16 0.19 0.35 0.37 0.03 0.24 0.15 0.09 0.03 0.12 0.12

0.97 0.93 0.30 0.72 0.74 0.78 0.94 1.09 1.11 1.06 0.98 0.99 0.94 0.57 0.47 1.03 0.67 0.94 1.09 1.05 1.12 0.95

2.38 3.11 4.32 3.01 3.73 2.13 3.06 2.42 2.39 2.90 1.70 2.50 2.76 4.24 4.40 1.33 3.20 2.38 1.85 1.29 2.13 2.13

1.00 0.48 1.70 0.83 1.51 0.77 1.42 0.69 1.90 0.97 0.68 0.30 1.62 0.79 1.16 0.54 1.32 0.58 1.82 0.82 0.27 0.13 1.16 0.55 1.35 0.65 2.05 1.07 1.84 0.98
0.12
0.05 1.57 0.77 1.29 0.55 0.59 0.27
0.08
0.02 0.97 0.43 0.73 0.35

1.43 2.22 5.50 2.36 2.95 1.27 2.13 1.47 1.59 2.12 0.67 1.57 1.84 3.99 4.34 0.29 2.75 1.78 0.94 0.32 1.27 1.17

1.5 1.1

9.0 0.4

0.04 0.00

1.00
0.01

1.46 1.05

0.00 0.00 0.00
0.28

0.40 0.00

Note: *None of the t-statistics is significant at the 5 per cent level

Stock mutual funds 1. Amer Funds EuroPac A 2. Amer Funds New Persp A 3. Amer Funds CplncBldr A 4. Templeton Growth A 5. Amer Funds CapWrldGI A 6. Templeton Foreign A 7. Fidelity Diversified Int 8. Putnam Intl Equity A 9. Janus Worldwide 10. Oppenheimer Glob A 11. Vanguard Intl Gr 12. Vanguard Eur Stk Idx 13. Harbor Intl Instl 14. First Eagle Overseas A 15. First Eagle Glbl A 16. T. Rowe Price Intl Stk 17. Tweedy, Browne Glob Val 18. Oakmark International I 19. AmCent Intl Growth Inv 20. Templeton Devel Mkts A 21. Columbia Acorn Intl Z 22. Fidelity Worldwide Benchmarks S&P500 US 90-day Treasury bill

S&P500 Assets AVG STD Sharpe M Alpha ($ million) (%) (%) measure Beta squared Alpha t-stat* Treynor 33,798 30,630 23,525 17,038 16,744 14,028 13,559 12,451 10,965 9,113 7,639 7,484 6,284 4,935 4,860 4,597 4,189 3,691 3,195 2,316 1,680 957

2.4 3.1 2.7 2.8 3.3 2.0 3.0 2.7 2.8 3.3 1.7 2.6 2.8 3.3 3.1 1.4 2.9 2.7 2.1 1.4 2.5 2.2

9.5 9.1 4.5 7.9 7.4 8.3 9.0 10.6 11.9 11.0 9.3 9.7 9.1 6.5 5.5 9.7 7.8 11.4 11.6 13.0 11.9 9.3

0.15 0.23 0.36 0.22 0.30 0.12 0.22 0.15 0.15 0.20 0.07 0.16 0.19 0.35 0.37 0.03 0.24 0.15 0.09 0.03 0.12 0.12

0.91 0.95 0.38 0.73 0.76 0.72 0.84 1.01 1.16 1.07 0.91 0.96 0.88 0.47 0.42 0.95 0.68 0.92 1.01 1.03 1.01 0.93

2.35 3.08 4.27 2.98 3.68 2.11 3.02 2.39 2.37 2.87 1.69 2.48 2.73 4.19 4.35 1.33 3.17 2.36 1.84 1.29 2.11 2.12


0.42 0.19 0.88 0.27 0.69
0.44 0.32
0.41
0.54 0.12
1.14
0.35
0.02 1.35 1.20
1.60 0.49
0.17
0.98
1.70
0.58
0.74


0.29 0.04
0.23
0.15 0.11
0.52 0.00
0.18
0.09 0.12
0.65
0.20
0.13 0.17 0.03
0.81
0.08
0.14
0.42
0.66
0.24
0.43

1.53 2.19 4.33 2.35 2.89 1.37 2.37 1.58 1.52 2.10 0.73 1.63 1.97 4.86 4.83 0.31 2.71 1.81 1.01 0.33 1.41 1.20

3.0 1.1

8.9 0.4

0.22 0.00

1.00 0.00

3.04 1.05

0.00 0.00
0.01
1.41

1.99 0.00

Performance of international mutual funds 17

Table VII.

Note: *None of the t-statistics is significant at the 5 per cent level

per cent. In comparison, the quarterly mean return of the benchmark EAFE index is 1.5 per cent and the quarterly mean return of the benchmark S&P500 index is 3.0 per cent. The fund with the highest total risk (measured by the standard deviation of returns) is Templeton Developing Markets with a quarterly standard deviation of 13.0 per cent. Again, in comparison, the standard deviation of the benchmark EAFE index is 9.0 per cent and the standard deviation of the benchmark S&P500 index is 8.9 per cent. Further, Tables VI and VII report the numerical values of the Sharpe measures, which are used to rank the funds in Tables VIII and IX. The highest Sharpe measure obtained (0.37) is by First Eagle Global. In comparison, the Sharpe measure of the benchmark EAFE index is 0.04 and the Sharpe measure of the benchmark S&P500 index is 0.22. Table VI also reports the values of fund Betas, M squared measures, Jensen’s Alphas (and their t-statistics), and Treynor measures, all of which are computed using the benchmark EAFE index. The fund with the highest systematic risk (Beta ¼ 1.12) is Columbia Acorn International. The fund with the highest M squared measure (4.40) is First Eagle Global. In comparison, the benchmark EAFE index has an M squared measure of 1.46. The fund with the highest Alpha measure is First Eagle Overseas with Alpha equal to 2.05. None of the fund Alphas is significantly different from zero. Finally, the fund with the highest Treynor measure (5.50) is American Funds Capital Income Builder. In comparison, the Treynor measure for the benchmark EAFE index is 0.40.

Ten year performance on a quarterly basis using the S&P500 index as benchmark (1994-2003)

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Table VIII. Ten-year ranking using the MSCI index as benchmark (1994-2003)

Stock mutual funds First Eagle Glbl A Amer Funds CplncBldr A First Eagle Overseas A Amer Funds CapWrldGI A Tweedy, Browne Glob Val Amer Funds New Persp A Fidelity Diversified Int Templeton Growth A Oppenheimer Glob A Harbor Intl Instl Vanguard Eur Stk Idx Putnam Intl Equity A Janus Worldwide Oakmark International I Amer Funds EuroPac A Fidelity Worldwide Templeton Foreign A Columbia Acorn Intl Z AmCent Intl Growth Inv Vanguard Intl Gr MSCI EAFE T. Rowe Price Intl Stk Templeton Devel Mkts A

Stock mutual funds

Table IX. Ten-year ranking using the S&P500 index as benchmark (1994-2003)

First Eagle Glbl A Amer Funds CplncBldr A First Eagle Overseas A Amer Funds CapWrldGI A Tweedy, Browne Glob Val Amer Funds New Persp A S&P500 Fidelity Diversified Int Templeton Growth A Oppenheimer Glob A Harbor Intl Instl Vanguard Eur Stk Idx Putnam Intl Equity A Janus Worldwide Oakmark International I Amer Funds EuroPac A Fidelity Worldwide Templeton Foreign A Columbia Acorn Intl Z AmCent Intl Growth Inv Vanguard Intl Gr T. Rowe Price Intl Stk Templeton Devel Mkts A

Sharpe rank (M Squared rank)

Treynor rank

Alpha rank

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

2 1 3 4 5 7 8 6 9 10 13 14 12 11 15 18 16 17 19 20 21 23 22

3 8 1 2 7 5 6 9 4 10 13 14 11 12 15 17 18 16 19 20 21 23 22

Sharpe rank (M Squared rank)

Treynor rank

Alpha rank

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

2 3 1 4 5 8 10 6 7 9 11 13 14 16 12 15 19 18 17 20 21 23 22

2 3 1 4 5 8 10 6 7 9 11 13 14 17 12 15 19 16 18 20 21 22 23

Table VII reports the values of fund Betas, M squared measures, Jensen’s Alphas (and their t-statistics), and Treynor measures, all of which are computed using the benchmark S&P500 index. The fund with the highest systematic risk (Beta=1.16) is Janus Worldwide. The fund with the highest M squared measure (4.35) is First Eagle Global. In comparison, the benchmark S&P500 index has an M squared measure of 3.04. The fund with the highest Alpha measure is First Eagle Overseas with Alpha equal to 1.35. None of the fund Alphas is significantly different from zero. Finally, the fund with the highest Treynor measure (4.86) is First Eagle Overseas. In comparison, the Treynor measure for the benchmark S&P500 index is 1.99. Tables VIII and IX report the rankings of all the funds based on the Sharpe, Treynor, and Alpha measures. It is interesting to note in Table VIII that only two funds underperform the EAFE index based on all three measures. On the other hand, Table IX shows that the S&P500 index is outperformed by merely six funds based on the Sharpe measure and nine funds based on Treynor and Alpha measures. Finally, the ten-year rankings of these funds appear to be more consistent than their five-year rankings with respect to the three different measures. Table X reports the average returns that accrue to the funds with and without riskadjustment. The risk-adjustment is performed by using only the MSCI EAFE index as the benchmark. The returns, once again, are annualized for the convenience of investors. First Eagle Overseas, which ranks first on the basis of mean (unadjusted) returns, falls back to rank three on the basis of returns adjusted for risk. On the other hand, First Eagle Global, which ranks fifth on an unadjusted basis, ranks first when the returns are adjusted for risk. The leverage factor for this fund is 1.65, which implies that an investor, who is comfortable with bearing the same level of risk as in the benchmark EAFE index, could lever the fund (borrow 65 per cent of his/her down payment, if possible, at the risk-free rate of return and invest in the fund) and thereby attain an annual return level of 18.81 per cent. The example below details how this return can be obtained. Consider an investor who would like to earn superior returns on an international mutual fund and, at the same time, bear only an average level of risk. In this context, the average level of risk is measured by the standard deviation of the benchmark EAFE index (which is 9.0 per cent on a quarterly basis). Now consider the following investment strategy. Suppose that the investor has $1,000 to invest. The investor could borrow an additional $650 and invest a total of $1,650 in First Eagle Global. The end of quarter gross return on the portfolio will be $1,6500.031 ¼ $51.15. Suppose that the borrowed funds were contracted at the quarterly risk-free rate of 1.1 per cent. In that case, the cost of borrowed funds is $650  0.011 ¼ $7.15. The portfolio return, net of interest cost, is $51.15
7.15 ¼ $44, which is a return of 4.4 per cent on a quarterly basis or 18.80 per cent (18.81 per cent in Table X due to rounding differences) on an annual basis. Note that the quarterly risk of this portfolio is 1.65  5.5 ¼ 9.1 per cent (or 9.0 per cent had the reported values not been rounded), which is equal to the quarterly standard deviation of the benchmark EAFE index. This investment strategy, therefore, enables the investor to earn superior returns for an average level of risk. Before discussing the results, it is worth noting the improvement of American Funds Capital Income Builder from an unadjusted rank of 12 to an adjusted rank of 2. This is due to the fact that it has the lowest quarterly standard deviation of 4.5 per cent, which translates into the highest leverage factor of 2.00. Finally, it may also be noted that the funds (and the benchmark EAFE index itself), which are ranked the lowest

Performance of international mutual funds 19

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Table X. Ten-year annualized performance: unadjusted and adjusted for risk

Stock mutual funds First Eagle Glbl A Amer Funds CplncBldr A First Eagle Overseas A Amer Funds CapWrldGI A Tweedy, Browne Glob Val Amer Funds New Persp A Fidelity Diversified Int Templeton Growth A Oppenheimer Glob A Harbor Intl Instl Vanguard Eur Stk Idx Putnam Intl Equity A Janus Worldwide Oakmark International I Amer Funds EuroPac A Fidelity Worldwide Templeton Foreign A Columbia Acorn Intl Z AmCent Intl Growth Inv Vanguard Intl Gr MSCI EAFE T. Rowe Price Intl Stk Templeton Devel Mkts A

Unadjusted annualized returns (%)

Unadjusted rank

Adjusted annualized returns (%)

Adjusted rank

Leverage factor

12.92 11.18 14.04 13.65 12.11 13.13 12.77 11.52 13.87 11.60 10.89 11.05 11.76 11.33 10.14 8.96 8.42 10.27 8.58 7.04 5.95 5.52 5.70

5 12 1 3 7 4 6 10 2 9 14 13 8 11 16 17 19 15 18 20 21 23 22

18.81 18.42 18.07 15.76 13.43 13.03 12.79 12.61 12.12 11.51 10.40 10.02 9.92 9.86 9.85 8.80 8.80 8.78 7.63 6.96 5.95 5.43 5.27

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

1.65 2.00 1.39 1.22 1.16 0.99 1.00 1.15 0.82 0.99 0.93 0.85 0.76 0.79 0.95 0.97 1.09 0.76 0.78 0.97 1.00 0.93 0.69

(ranks 15 through 23) on an unadjusted basis, continue to hold the lowest nine ranks on a risk-adjusted basis. Discussion Investors who want to invest in international mutual funds need to make, at least, two important decisions: one, which international mutual funds to hold, and two, how much money to invest in each. Regarding the first decision, this study uses the M squared measure to identify the mutual funds that yield the highest return per unit of risk. The contribution of this study to the existing body of literature is that it is one of the first studies that apply the new M squared measure to evaluate the performance of international mutual funds using both domestic and international benchmark indices. The results are reported in per centage terms in a manner, which is easily comprehensible to an average investor. This is in contrast to most studies on international mutual funds, which report risk-adjusted returns using absolute performance measures that are difficult to interpret. Regarding the second decision on how much money to invest, the study highlights the role of leverage in attaining a desired level of risk. For the benefit of an investor who is comfortable with an average level of risk (for example, the risk that exists in a portfolio indexed to the benchmark EAFE), this study presents the leverage factor that an investor needs to attain. Once again, this is in contrast to existing literature on the subject, which does not provide much guidance on the degree of leverage that would be needed to attain a desired level of return by investing in international mutual funds.

Conclusion This study provides documentation on the risk-adjusted performance of international mutual funds. The evaluation is based on objective performance measures grounded in modern portfolio theory. Using the methodology developed by Modigliani and Modigliani in 1997, the study reports the returns that would have accrued to these mutual funds, had the fund managers taken the same degree of risk as that which prevails in the benchmark EAFE index, for a five-year holding period as well as a tenyear holding period. It is evident from the empirical results of this study that the funds with the highest average returns may lose their attractiveness to investors once the degree of risk embedded in the fund has been factored into the analysis. Conversely, some funds, whose average (unadjusted) returns do not stand out, may look very attractive once their low risk is factored into their performance. This study also demonstrates how financial leverage can be used to raise the returns on international mutual funds with low risk. Alternatively, the risk of some funds can be lowered by unlevering the investor’s holding. The empirical evidence presented in this study can be used as input in decision-making by investors who are exploring the possibility of participating in the global stock market via international mutual funds, but are not sure of what selection criteria to employ. On a final note, future researchers may want to update the information presented in this study on a regular basis, for the benefit of investors who are evaluating investment opportunities in international mutual funds. It may also be worthwhile to research the effects of factors, such as fund manager compensation, service fees, corporate governance metrics, and overweighting in risky countries/regions, on the performance of international mutual funds. References Bailey, B.A., Heck, J.L. and Wilkens, K.A. (2005), ‘‘International mutual fund performance and political risk’’, Review of Pacific Basin Financial Markets and Policies, Vol. 8 No. 1, pp. 167-84. Carhart, M.M. (1997), ‘‘On persistence in mutual fund performance’’, Journal of Finance, Vol. 52, pp. 57-82. Chang, E.C. and Lewellen, W.G. (1984), ‘‘Market timing and mutual fund investment performance’’, Journal of Business, Vol. 57, pp. 57-72. Cumby, R.E. and Glen, J.D. (1990), ‘‘Evaluating the performance of international mutual funds’’, Journal of Finance, Vol. 45, pp. 497-521. Daniel, K., Grinblatt, M., Titman, S. and Wermers, R. (1997), ‘‘Measuring mutual fund performance with characteristic-based benchmarks’’, Journal of Finance, Vol. 52, pp. 1035-58. Droms, W.G. and Walker, D.A. (1994), ‘‘Investment performance of international mutual funds,’’ Journal of Financial Research, Vol. 17, Spring, pp. 1-14. Edwards, E. and Samant, A. (2003), ‘‘Investing with a conscience: an evaluation of the riskadjusted performance of socially responsible mutual funds’’, Mid-American Journal of Business, Vol. 18 No. 1, pp. 51-60. Eun, C.S., Kolodny, R. and Resnick, B.G. (1991), ‘‘US based international mutual funds: a performance evaluation’’, Journal of Portfolio Management, Vol. 17, Spring, pp. 88-94. Henrikkson, R.D. and Merton, R.C. (1981), ‘‘On market timing and investment performance II: statistical procedures for evaluating forecasting skills’’, Journal of Business, Vol. 54, pp. 513-33.

Performance of international mutual funds 21

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Jensen M.C. (1968), ‘‘The performance of mutual funds in the period 1945-64’’, Journal of Finance, Vol. 23, pp. 389-416. Kon, S.J. and Jen, F.C. (1979), ‘‘The investment performance of mutual funds: an empirical investigation of timing, selectivity, and market efficiency’’, Journal of Business, Vol. 52, pp. 263-89. Kothari, S.P. and Warner, J.B. (2001), ‘‘Evaluating mutual fund performance’’, Journal of Finance, Vol. 56, pp. 1985-2010. Modigliani, F. and Modigliani, L. (1997), ‘‘Risk-adjusted performance’’, Journal of Portfolio Management, Vol. 23, Winter, pp. 45-54. Morningstar (1999), ‘‘Mutual Fund 500’’, Morningstar. Morningstar (2004), ‘‘Funds 500’’, Morningstar. Redman, A.L., Gullett, N.S. and Manakyan, H. (2000), ‘‘The performance of global and international mutual funds’’, Journal of Financial and Strategic Decisions, Vol. 13, pp. 75-85. Samant, A. and Edwards, E. (2000), ‘‘Evaluating international mutual funds using risk-adjusted performance measures’’, Journal of Global Business, Vol. 11 No. 21, Fall, pp. 15-24. Sharpe, W.F. (1966), ‘‘Mutual fund performance’’, Journal of Business, Vol. 39, pp. 119-38. Treynor, J.L. (1965), ‘‘How to rate management of investment funds’’, Harvard Business Review, Vol. 43, pp. 63-75. Corresponding author Onur Arugaslan can be contacted at: [email protected]

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Why do firms issue global bonds? Oranee Tawatnuntachai School of Business Administration, Penn State Harrisburg, Middletown, Pennsylvania, USA, and

Why do firms issue global bonds?

Devrim Yaman

23

Department of Finance and Commercial Law, Haworth College of Business, Western Michigan University, Kalamazoo, Michigan, USA Abstract Purpose – This paper aims to examine the motivations of firms that issue global bonds. Specifically, it seeks to test whether firms are motivated to offer bonds in multi-markets to raise more capital, take advantage of being well-known in foreign markets and/or owing to poor domestic economic conditions. Design/methodology/approach – A sample of global bond offerings of US industrial firms during the period 1995 to 2001 was studied. Logistic regressions were used to examine the determinants of the choice between global and domestic debt offerings. The factors that explain the stock price reaction of global bond issues were also analyzed. Findings – The authors find evidence suggesting that firms with a good reputation abroad and firms that want to raise large amounts of funds choose to issue global bonds instead of domestic bonds. Firms also tend to issue global bonds when the domestic economy is weak. In addition, the stock markets do not react more positively to global bond issues than domestic bond issues, suggesting that the issuing cost of global bonds is not lower than the cost of domestic bonds. Research limitations/implications – Future researchers may want to investigate why some firms choose to issue global bonds while others choose Eurobonds when they want to issue debt internationally. Practical implications – The findings of this study suggest that, although firms might be able to raise more capital by issuing global bonds, the issuing costs are not lower. Originality/value – This is the first paper to study the determinants of the choice between global bonds and domestic bonds and examine the factors that affect the stock price reaction to global bonds. Keywords Bonds, Debts, Stock prices Paper type Research paper

Introduction Global bonds are bonds sold simultaneously in several major capital markets in Asia, Europe and USA. The first global bond was introduced by the World Bank in September 1989 and the first global bond by a private non-financial corporation was issued in 1992[1]. Since then, the amount of capital raised through global bond offerings by private corporations has increased significantly. The issues by US industrial firms alone increased from $2.8 billion in 1996 to 47.9 billion in 2001 – up more than 1,500%[2]. Although global bonds became considerably popular in recent years, they have received little attention in the academic literature. In fact, to our knowledge, the only paper that examines these securities is by Puthenpurackal (2001) who studies the direct costs of borrowing for global bonds. Puthenpurackal finds that at-issue yields and underwriting fees for global bonds are 15 and 12 basis points lower than those for domestic bonds. He also reports that liquidity of global bonds is higher than that of domestic bonds and global bond issues increase shareholder wealth. Similar to the findings of Puthenpurackal (2001), prior studies that examine simultaneous equity offerings in different markets find that simultaneous offerings have lower issuing costs than domestic equity issues. For example, Marr et al. (1991)

Managerial Finance Vol. 34 No. 1, 2008 pp. 23-40 # Emerald Group Publishing Limited 0307-4358 DOI 10.1108/03074350810838208 .

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report that Euroequity issues with a large offshore tranche are associated with lower stock price declines than domestic issues. Chaplinsky and Ramchand (2000) find that the stock price reaction to global equity issues is 0.8 per cent higher than the reaction to domestic offerings with similar issue size and filing period[3]. In this study, we examine the motivations of firms that issue global bonds. Specifically, we test whether firms are motivated to offer global bonds to raise larger amounts of capital, to take advantage of their favorable reputation abroad and/or because of poor domestic economic conditions. Because firms can market global bonds to a large investor base in several major markets of the world, they can sell the bonds at a higher price and hence raise larger proceeds than bonds placed only in the domestic markets. Firms that are well-known abroad will also have more opportunities to create demand for their securities globally. Therefore firms with favorable reputation abroad will be more likely to issue global bonds. During poor domestic economic conditions, firms will also have more motivation to tap in the demand from the world markets. To test these hypotheses, we compare the debt issue decision of global issuers with that of firms that have the opportunity to raise capital in both domestic and foreign markets but choose to issue domestic bonds. In addition, we compare the overall costs of issuing global and domestic bonds using stock returns during the announcements of these bonds as a proxy for the issue costs. The stock returns capture not only effects of debt yield and underwriting spread but also other indirect benefits and costs of debt issues on equity value of shareholders such as wealth transfer from existing debtholders to the shareholders. The indirect effects are important especially when a levered firm issues substantial debt (Choe et al., 1993). We also test whether firms’ reputation abroad and conditions of domestic capital markets have significant impact on the stock market reactions to the announcements of global bond issues. Using a sample of 125 global bond offerings filed by US industrial firms during 1995-2001, we find that global bonds are issued by firms that want to raise large amounts of capital and firms with high reputation abroad[4]. We also find evidence that firms choose to raise capital through global bond issues during periods of low domestic economic performance. Global bond issuers do not experience significantly different stock market reactions during the bond issue announcement period from domestic bond issuers. This suggests that although the direct issuing costs for global bonds are lower (Puthenpurackal, 2001), the overall issuing costs (i.e. both direct and indirect) for global bonds are similar to those of domestic bonds. However, when firms choose to issue global bonds during periods of high domestic interest rates, the stock returns are higher. This may be a result of lower financing costs that the firms can obtain from global markets compared to domestic markets during high domestic interest rate periods. The rest of this paper is organized as follows: the next section discusses the testable hypotheses on the motivations of firms to choose global bonds over domestic bonds and on the stock market reactions to the choice; the section that follows describes the sample selection process, sample characteristics and the matching process; the last two sections analyze the results and conclude the paper. Testable hypotheses Motivations of firms issuing global bonds In this section, we develop the hypotheses that might explain why some firms that have access to both domestic and foreign capital markets choose to issue global bonds,

while others that have the same opportunity decide to sell bonds, only in the domestic markets. Issue size Chaplinsky and Ramchand (2000) report that the average size of global equity issues is significantly larger than the size of domestic issues. We would expect firms that want to obtain large amounts of debt financing also choose to go to global markets. Because global bonds are sold in several markets of the world at the same time, they can reach a broader pool of investors. As a result, firms can sell larger issues without having to lower the price as they might have to do if the bonds were offered only in the domestic markets. Recognition abroad Wright (1998) argues that simultaneous offerings in multi markets are in general large offers. These offerings have a higher chance of success if they are issued by well-known companies. Because global bonds are marketed to investors all over the world, firms with high recognition abroad can easily create high and worldwide demand for their bonds, especially compared to firms that are known only domestically. Merton (1987) argues that an issuer’s cost of capital is lower when the firm has a higher proportion of investors who are informed about the firm’s operations. His argument suggests that firms that are well-known in international markets could lower their cost of capital by selling bonds in multi markets. His argument also implies that firms with high reputation abroad are more likely to issue global bonds. Domestic market conditions Global bonds might offer an opportunity for firms to escape the unfavorable conditions in the domestic markets. In this study, we test whether the domestic interest rates, domestic economic performance and the value of the local currency influence firms’ decision to issue global bonds. In order to maximize profits, firms will attempt to lower cost of capital. Because global bonds can be sold in both domestic and foreign markets, firms will be more likely to issue global bonds when the issuing costs in the domestic capital markets are high. In their survey paper, Graham and Harvey (2001) report that corporate executives view that interest rate level is an important factor in the debt issue decision. Similarly, Miller and Puthenpurackal (2002) show that the interest costs affect firms’ choice between Yankee bonds and Eurobonds. Thus, when the interest rate in the domestic markets is high, firms that have an opportunity to raise capital abroad will choose to offer global bonds instead of domestic bonds in order to minimize the borrowing cost. Economic conditions in the home country of the issuers might also affect the choice between global and domestic bonds. To the extent that poor conditions in the domestic economy lower the demand for securities, firms will choose to issue bonds globally during economic downturns. Similarly, when the local currency is weaker, the demand for domestic securities from foreign investors will rise because the securities become cheaper for these investors. Under imperfect capital markets, an upward shift in demand will push up offering price and hence reduce the issuing cost. Therefore, to minimize the cost of borrowing, firms will likely issue global bonds during domestic economic downturns or during periods of weak local currency in order to tap in extra demand from external markets.

Why do firms issue global bonds? 25

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In summary, in order to minimize the debt issuing cost, firms will choose to sell bonds globally when domestic markets experience high interest rates, low economic performance levels and/or weak local currency. The stock market reactions In this study, we also test whether the overall costs of issuing global bonds are lower than those of domestic bonds and whether firm-characteristics and domestic market conditions affect the costs of issuing global bonds. Smith (1986) argues that the stock price reaction at issue announcements measures the costs of security issuance. Stock returns during debt issue announcement periods capture both the interest cost of debt (debt yield) and the benefits and costs of debt issuance to shareholders. The benefits and costs to shareholders include wealth transfers from current bondholders to shareholders. As in Kim and Stulz (1988) and Krishnaswami and Yaman (2005), we use the stock market reaction to measure the overall costs for debt issuance. The findings of prior studies on stock returns of straight debt offerings issued in domestic markets are mixed. While Eckbo (1986) finds insignificant abnormal returns, Dann and Mikkelson (1984) and Krishnaswami and Yaman (2005) report significantly negative stock price reactions during the announcement period of the completed debt issuance by US firms. For debt issued in international markets, Kim and Stulz (1988) and Miller and Puthenpurackal (2002) find positive abnormal returns during the announcements of Eurobonds and Yankee bonds. They conclude that issuing securities outside domestic markets provide certain benefits to shareholders. Due to their characteristics, global bonds offer two potential advantages over domestic bonds: higher liquidity and lower borrowing cost. Global bonds are different from domestic bonds in several ways. First, global bonds are distributed in both domestic markets and abroad, and hence reach a broader pool of investors. Second, global bonds are typically listed on many major exchanges and therefore can be traded around the clock due to overlapping trading periods of the world’s major exchanges. Third, although global issues must be registered with the US Securities Exchange Commission (SEC) if they are placed in the US markets, the bonds can be sold without the 40-day lock up period required by SEC for Eurobonds. This allows investors to trade the bonds immediately after acquiring them. Fourth, global bonds are book-entry bonds and hence there is no physical delivery. This reduces the barrier of settlement among different markets[5]. These characteristics of global bonds generate higher demand and thus increase competition for the bonds. Under a downward sloping demand curve, higher demand will increase offer prices which in turn will lower yields for the bonds. Consistent with these arguments, Puthenpurackal (2001) finds that global bonds are more liquid securities and have lower yields and underwriting fees than domestic bonds. He finds that the bid-ask spreads of global bonds are significantly lower than domestic bonds while the average at-issue-yield and gross underwriting spreads are 12 and 12.2 basis points lower than those of domestic bonds respectively[6]. Because of higher liquidity and lower direct costs of borrowing, the stock markets should react more positively to the announcements of global bonds than to those of domestic bonds. Merton (1987) argues that investors purchase only securities of firms that they know about and hence a firm’s cost of capital is inversely related to the number of informed investors. His argument suggests that firms that are well-known abroad will have easier access to foreign capital markets. Therefore, these firms will obtain greater

benefits from offering global bonds. This implies that firms with high reputation abroad will experience higher abnormal returns during global bond issues. Firms might also be able to lower their issue costs by offering bonds globally during unfavorable domestic bond market conditions. Therefore, the benefits of global bond issuance to shareholders should be higher when the conditions in domestic capital markets are poor. For example, firms that issue global bonds during high domestic interest rate might be able to offer lower yields in foreign markets. Similarly, when domestic economy experiences slow growth, global bond issuers can access international markets for external funds. In addition, when local currency is weak, domestic securities become cheaper for foreign investors. This makes domestic securities easier to sell in foreign markets. These arguments suggest that the benefits of global bond issuance are more pronounced when firms can escape the unfavorable economic conditions in the domestic markets. Therefore, the stock markets should react more positively to the bonds announced during periods of high interest rate, low economic performance and/or weak domestic currency. Sample selection and characteristics Sample selection process We obtain both global and domestic bond data from the Securities Data Corporation (SDC)’s New Issues Database. Global bonds are defined as bonds placed simultaneously in the US market and global markets, and domestic bonds are those that are sold exclusively in the US market. Our sample consists of completed bonds offerings by US firms filed between 1995 and 2001. We restrict our sample to publicly placed straight debts because private placement debts and convertible debts are rare for global bonds. In addition, the stock market reactions to straight debts are different from the reactions to other types of bonds such as convertible bonds (Dann and Mikkelson, 1984; Eckbo 1986; Mikkelson and Partch, 1986). We also focus on offers made by industrial firms because the motives for raising capital and the stock price effects of security issues are different for regulated firms (Eckbo, 1986; Slovin et al., 1991). Our final sample consists of 125 global and 3,441 domestic publicly placed straight bonds filed by 48 and 1,009 industrial firms respectively during 1995-2001[7]. Table I presents the frequency distribution of the sample by year. Overall, the number of global bond offerings increases over the sample period. The total number of global bond filings during 1999-2001 (95 filings) was more than three times as many as the filing during 1995-1998 (30 filings). The maximum number of global bond filings was made in 1999 (38 filings) and the minimum number of filings was in 1997 (1 filing). In contrast, the number of domestic bond offerings declined over the sample period. The maximum number of domestic bond filings (684 filings) was in 1996 and the minimum number of filings (251 filings) was in 2000. The number of firms issuing global bonds also increased significantly from 1995 to 2001. During 1999-2001, 32 firms raised capital by issuing global bonds. This was twice the number of firms (16) that file global bonds during 1995-1998. On the other hand, the number of firms issuing domestic bonds declined from the highest of 205 in 1996 to the lowest of 79 in 2000. Although the proceeds raised through global bonds were less than those of domestic bonds each year, they increase from $19.5 billion during 1995-1998 to $104.9 billion during 1999-2001 – an increase of more than five folds. These statistics show that global bonds have gained popularity in recent years.

Why do firms issue global bonds? 27

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Number of filings Global Domestic 1995 1996 1997 1998 1999 2000 2001 Total

Table I. Frequency distribution of global and domestic bonds

2 10 1 17 38 27 30

(1.6) (8.0) (0.8) (13.6) (30.4) (21.6) (24.0)

125 (100)

439 684 632 634 418 251 383

(12.8) (19.9) (18.4) (18.4) (12.2) (7.3) (11.1)

3,441 (100)

Number of firms Global Domestic 1 6 1 8 11 10 11

(2.1) (12.5) (2.1) (16.7) (22.9) (20.8) (22.9)

48 (100)

109 205 191 196 130 79 99

(10.8) (20.3) (18.9) (19.4) (12.9) (7.8) (9.8)

1,009 (100)

Global 2,598 6,135 995 9,781 37,086 39,026 28,829

Issue size Domestic

(2.1) (4.9) (0.8) (7.9) (29.8) (31.4) (23.2)

124,450 (100)

49,708 80,313 93,236 117,955 109,255 62,596 90,767

(8.2) (13.3) (15.4) (19.5) (18.1) (10.4) (15.0)

603,830 (100)

Notes: This table presents frequency distribution of publicly placed global and domestic straight debt offerings filed by US industrial firms during the period of 1995-2001. Global bonds are defined as bonds placed simultaneously in the US market and in global markets, and domestic bonds are those that are sold exclusively in the US market. Both global and domestic bond data is obtained from SDC database. Issue size is offering proceeds from all markets in million dollars. The numbers in parentheses represent percentage of total observations

Sample characteristics Table II provides information about firm and issue characteristics for both global and domestic bonds. Firm characteristic data is obtained from Compustat PC Plus, and issue data is from SDC Database. Based on both means and medians, global bond issuers are significantly larger than domestic bond issuers in terms of book value of total assets and market value of common equity. They have lower financial leverage and have higher market-to-book ratio, defined as market value to book value of total assets, than domestic bond issuers. These findings suggest that global issuers are high quality and high growth firms. The results are consistent with the findings of Kim and Stulz (1988) in the context of Eurobond issues and Chaplinsky and Ramchand (2000) and Wu and Kwok (2002) in the context of global equity offerings. Although total foreign income for global bond issuers is higher than that for domestic bond issuers, foreign income relative to net sales and relative to market value of equity are similar for both sub-samples. This finding is in contrast to the evidence documented by Chaplinsky and Ramchand (2000) who find that global equity issuers have higher foreign income to sales than domestic equity issuers. Issue size of global bonds is about nine times as large as the size of domestic bonds. However, the mean issue size relative to firm value (market value of equity) is lower for global bonds than for domestic bonds. This finding is consistent with the finding of Chaplinsky and Ramchand (2000) in the context of global equity offerings. On average, global bonds have shorter maturities than domestic bonds. About 1 per cent of global bonds and 3 per cent of domestic bonds are subordinated bonds. Most global bonds (93.60 per cent) are rated as investment grade (BBB and above) by Moody’s, compared to 90 per cent of domestic bonds. Overall, the results in Table II suggest that global bonds are associated with different firm and issue characteristics than domestic bonds. Matching process The focus of this paper is to examine the motivations of firms that choose to issue global bonds instead of domestic bonds and the stock market reactions to this choice. The analysis of these issues requires the comparison of firms that have the opportunity

Variables Total assets Market value of equity Debt ratio Market-to-book ratio Foreign income Std. foreign income_1 Std. foreign income_2 Std. excess cash flow Issue size Std. issue size Maturity (years) % Non-subordinated % Investment grade

Global bonds

Domestic bonds

Difference

50,768.89 (36,536.50) 94,582.60 (80,795.50) 28.23 (22.57) 3.05 (2.26) 1,420.40 (335.40) 3.33 (2.70) 3.11 (2.01) 2.17 (6.25) 995.60 (891.60) 3.05 (1.13) 9.31 (7.00) 99.20 93.60

12,395.99 (55,91.00) 15,751.34 (5,821.48) 32.13 (29.30) 1.96 (1.64) 541.96 (93.00) 3.03 (3.02) 3.02 (2.02) 4.03 (4.40) 175.48 (100.00) 6.38 (1.79) 11.01 (9.00) 96.92 90.03