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SECTION III

WHY FOREIGNERS INVEST IN THE UNITED STATES

In the course of this study, most of the interviewees were asked to respond to a questionnaire. The purpose of the questionnaire was to evaluate the relative importance of different factors affecting foreign portfolio investment. A summary of the responses of foreign investors is shown in Figure 2. This chart indicates that the main reasons why foreigners invest internationally are to preserve capital, to achieve long-term capital growth, and to be harbored in countries that are politically and economically stable. Perhaps the most important reason of all, however, is simply to achieve the greater rewards, or reduced risks, of international diversification. This concept is not well understood by U.S. portfolio managers in general, and yet is almost taken for granted by their foreign

counterparts.

Figure 3 shows U.S. portfolio managers' responses to the same questionnaire. The most significant difference, the importance to foreign investors of long term capital growth, is discussed later in this Section.

Many foreign funds are invested 20% to 80% internationally; typically, the U.S. accounts for about half of this investment. The purpose of this section is to examine in some detail the reasons why foreign portfolio managers invest internationally, and especially in the U.S. The most important reasons are

reviewed below:

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TABULATION OF FOREIGN PORTFOLIO MAI JAGGERS RESPONSES TO THE QUESTION

"DO YOU AGREE THAT THE FOLLOWING FACTOR IS AN IMPORTANT CONSIDERATION AFFECTING FOREIGN PORTFOLIO INVESTMENT?"

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Note: The total number of respondents represented in the above results is 51.

FIGURE 3

TABULATION OF RESPONSES OF U.S. PORTFOLIO MANAGERS AND INTERMEDIARIES TO THE QUESTION

"Do You AGREE THAT THE FOLLOWING FACTOR IS AN IMPORTANT CONSIDERATION AFFECTING FOREIGN PORTFOLIO INVESTMENT?

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1.

Diversification of Investment Portfolios Internationally
Improves Performance or Lowers Risk

An important concept still largely in the theoretical stages is

based on the fact that the capital markets of the world do not move up

and down in perfect synchronization. The degree to which these markets are not synchronized (this degree is measurable in statistical terms) provides opportunities to improve risk-reward ratios.

The same principle is involved when a U.S. portfolio manager diversifies by investing in different industries. Considerable analytical effort is devoted to ensure that the performance of the different industries invested in are not too closely tied to each other. Otherwise, the investor may as well concentrate in what he believes to be the best industry rather than diversify in the first place.

One U.S. mutual fund manager has studied the benefits of international diversification extensively. He states that portfolio managers could achieve "perhaps a 20% to 40% reduction in portfolio variability or risk without sacrificing return." He also says, however, that "thus far the U.S. investment community has reacted with a great collective yawn." Ironically, the theoretical aspects seem to have been analyzed more thoroughly and been better understood by U.S. analysts; the practical aspects, however, are

definitely better applied by foreign investment portfolio investors.

(Paradoxically, U.S. firms engaged in direct investment abroad appear to have a sophisticated and highly developed understanding of the practical benefits of international investment.)

2. Expectations for Long-Term Capital Growth

Almost every foreign portfolio manager cited "long-term capital gains" as the major objective of investments in the U.S. (see Figure 2). Interestingly, U.S. managers don't believe that this objective is as important to foreigners (Figure 3). The discrepancy may be explained by the different interpretation each places on the phrase. A long term growth strategy for U.S. investors is to buy and hold stocks in companies whose earnings are expected to grow, until such growth is reflected in the stock price. A long term growth strategy for foreign investors is to commit investment funds to a growing market, but not necessarily to specific securities. Consequently, their investment strategy includes taking short-term profits in particular securities when they occur, while nonetheless preserving the objective of long-term capital growth. This strategy is made possible because foreign portfolio investors are exempt, in the majority of cases, from U.S. capital gains taxes on security transactions. (See also the tax section in "Legal Aspects of Foreign Portfolio Investment in the United States.")

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