by International equity markets are an important platform for global finance. They not only ensure the participation of a wide variety of participants but also offer global economies to prosper.
An equity market is a market in which shares of companies are issued and traded, either through exchanges or over-the-counter markets. Also known as the stock market, it is one of the most vital areas of a market economy. It gives companies access to capital to grow their business, and investors a piece of ownership in a company with the potential to realize gains in their investment based on the company’s future performance.
To understand the importance of international equity markets, market valuations and turnovers are important tools. Moreover, we must also learn how these markets are composed and the elements that govern them. Cross-listing, Yankee stocks, ADRs and GRS are important elements of equity markets.
The secondary equity markets provide marketability and share valuation. Investors or traders who purchase shares from the issuing company in the primary market may not desire to own them forever. The secondary market permits the shareholders to reduce the ownership of unwanted shares and lets the purchasers to buy the stock.
The secondary market consists of brokers who represent the public buyers and sellers. There are two kinds of orders:
Market order: A market order is traded at the best price available in the market, which is the market price.
Limit order: A limit order is held in a limit order book until the desired price is obtained.
There are many different designs for secondary markets. A secondary market is structured as a dealer market or an agency market.
In a dealer market, the broker takes the trade through the dealer. Public traders do not directly trade with one another in a dealer market. The over-the-counter (OTC) market is a dealer market.
In an agency market, the broker gets client’s orders via an agent.
Cross-listing
Cross-listing refers to having the shares listed on one or more foreign exchanges. In particular, MNCs do this generally, but non-MNCs also cross-list. A firm may decide to cross-list its shares for the following reasons:
- Cross-listing provides a way to expand the investor’s base, thus potentially increasing its demand in a new market.
- Cross-listing offers recognition of the company in a new capital market, thus allowing the firm to source new equity or debt capital from local investors.
- Cross-listing offers more investors. International portfolio diversification is possible for investors when they trade on their own stock exchange.
- Cross-listing may be seen as a signal to investors that improved corporate governance is imminent.
- Cross-listing diminishes the probability of a hostile takeover of the firm via the broader investor base formed for the firm’s shares.
Trading In International Equities
A greater global integration of capital markets became apparent for various reasons:
- Investors understood the good effects of international trade.
- The prominent capital markets got more liberalized through the elimination of fixed trading commissions.
- Internet and information and communication technology facilitated efficient and fair trading in international stocks.
- The MNCs understood the advantages of sourcing new capital internationally.
American Depository Receipts (ADR)
An ADR is a receipt that has a number of foreign shares remaining on deposit with the U.S. depository’s custodian in the issuer’s home market. The bank is a transfer agent for the ADRs that are traded in the United States exchanges or in the OTC market.
ADRs offer various investment advantages. These advantages include:
- ADRs are denominated in dollars, trade on a US stock exchange, and can be purchased through the investor’s regular broker. This is easier than purchasing and trading in US stocks by entering the US exchanges.
- Dividends received on the shares are issued in dollars by the custodian and paid to the ADR investor, and a currency conversion is not required.
- ADR trades clear in three business days as do U.S. equities, whereas settlement of underlying stocks vary in other countries.
- ADR price quotes are in U.S. dollars.
- ADRs are registered securities and they offer protection of ownership rights. Most other underlying stocks are bearer securities.
- An ADR can be sold by trading the ADR to another investor in the US stock market, and shares can also be sold in the local stock market.
- ADRs frequently represent a set of underlying shares. This allows the ADR to trade in a price range meant for US investors.
- ADR owners can provide instructions to the depository bank to vote the rights.
There are two types of ADRs: sponsored and unsponsored.
- Sponsored ADRs are created by a bank after a request of the foreign company. The sponsoring bank offers lots of services, including investment information and the annual report translation. Sponsored ADRs are listed on the US stock markets. New ADR issues must be sponsored.
- Unsponsored ADRs are generally created on request of US investment banking firms without any direct participation of the foreign issuing firm.
Global Registered Shares (GRS)
GRS are a share that are traded globally, unlike the ADRs that are receipts of the bank deposits of home-market shares and are traded on foreign markets. The GRS are fully transferrable GRS purchased on one exchange can be sold on another. They usually trade in both US dollars and euros.
The main advantage of GRS over ADRs is that all shareholders have equal status and the direct voting rights. The main disadvantage is the cost of establishing the global registrar and the clearing facility.
International Equity Market Benchmarks
The World Equity Benchmark Series (WEBS) was an international fund traded on the American Stock Exchange. It was introduced in 1996 by Morgan Stanley and was a type of hybrid security that possesses qualities of both open-end and closed-end funds.
In 2000, WEBS was renamed to iShares MSCI Emerging Markets Exchange Traded Fund (ETF). The iShares MSCI Emerging Markets ETF seeks to track the investment results of the MSCI Emerging Markets Index, an index composed of large- and mid-capitalization emerging market equities.
A closed-end fund is a fund formed as a publicly traded investment. These funds can raise a designated amount of capital with an initial public offering. The money collected goes into a fund that is then listed as a stock and traded on a public exchange. It is a specialized stock portfolio with a one-time fixed number of shares. An open-end fund is a conventional mutual fund, made up of a pool of money from many investors for investing in stocks and bonds. Investors share gains and losses in proportion to their investment in the fund.
An organization that used a WEBS owned each of the securities traded on the MSCI country indexes. Ownership was in an approximate ratio to the initial capitalization or investment. A WEBS could be bought, sold, and traded like stocks.
Investors could use the WEBS to achieve international diversification. The World Equity Benchmark Series was available for many different countries, including Australia, Austria, Belgium, Canada, France, Germany, Hong Kong, Italy, Japan, Malaysia, Mexico, the Netherlands, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
The name change of the World Equity Benchmark Series (WEBS) to iShares MSCI Emerging Markets ETF was intended to reflect the consistent brand name for all exchange-traded funds managed by Barclays Global Investors (now BlackRock).
At the time, the indexes included iShares MSCI Australia, iShares MSCI Austria, iShares MSCI Belgium, iShares MSCI Canada, iShares MSCI France, iShares MSCI Germany, iShares MSCI Hong Kong, iShares MSCI Italy, iShares MSCI Japan, iShares MSCI Malaysia, iShares MSCI Mexico, iShares MSCI Netherlands, iShares MSCI Singapore, iShares MSCI South Korea, iShares MSCI Spain, iShares MSCI Sweden, iShares MSCI Switzerland, and iShares MSCI United Kingdom.
Benchmarks are indexes created to include multiple securities representing some aspect of the total market. Benchmark indexes have been created across all types of asset classes. In the equity market, the S&P 500 and Dow Jones Industrial Average are two of the most popular large-cap stock benchmarks.
In fixed income, examples of top benchmarks include the Barclays Capital U.S. Aggregate Bond Index, the Barclays Capital U.S. Corporate High Yield Bond Index, and the Barclays Capital U.S. Treasury Bond Index. Mutual fund investors may use Lipper indexes, which use the 30 largest mutual funds in a specific category, while international investors may use MSCI Indexes. The Wilshire 5000 is also a popular benchmark representing all of the publicly traded stocks in the U.S. When evaluating the performance of any investment, it’s important to compare it against an appropriate benchmark.
Identifying and setting a benchmark can be an important aspect of investing for individual investors. In addition to traditional benchmarks representing broad market characteristics such as large-cap, mid-cap, small-cap, growth, and value. Investors will also find indexes based on fundamental characteristics, sectors, dividends, market trends, and much more. Having an understanding or interest in a specific type of investment will help an investor identify appropriate investment funds and also allow them to better communicate their investment goals and expectations to a financial advisor.
When seeking investment benchmarks, an investor should also consider risk. An investor’s benchmark should reflect the amount of risk they are willing to take. Other investment factors around benchmark considerations may include the amount to be invested and the cost the investor is willing to pay.
Factors Affecting International Equity Returns
Exchange Rates
Adler and Simon (1986) tested the sample of foreign equity and bond index returns to exchange rate changes. They found that exchange rate changes generally had a variability of foreign bond indexes than foreign equity indexes. However, some foreign equity markets were more vulnerable to exchange rate changes than the foreign bond markets.
Macroeconomic Factors
Solnik (1984) examined the effect of exchange rate fluctuations, interest rate differences, the domestic interest rate, and changes in domestic inflation expectations. He found that international monetary variables had only weak influence on equity returns. Asprem (1989) stated that fluctuations in industrial production, employment, imports, interest rates, and an inflation measure affect a small portion of the equity returns.
Industrial Structure
Roll (1992) concluded that the industrial structure of a country was important in explaining a significant part of the correlation structure of international equity index returns.
In contrast, Eun and Resnick (1984) found that the correlation structure of international security returns could be better estimated by recognized country factors rather than industry factors.
Heston and Rouwenhorst (1994) stated that “Industrial structure explains very little of the cross-sectional difference in country returns volatility, and that the low correlation between country indices is almost completely due to country-specific sources of variation.”
