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B.

Factors which influence the industry composition of a portfolio

include:

The relative growth prospects for specific industry sectors

within a country. Recently, for example, foreign investors have ex

pressed optimism about the outlook for the oil and gas producers in the

U.S., as well as other companies involved in natural resources.

The history and forecast of earnings for individual companies,

especially 6 months to a year in the future. Given two companies

with the same average earnings growth rate, the company with the more

stable growth pattern is generally considered to be less risky. This is

taken into account when comparing the current prices of the two stocks

relative to their earnings. (Much more importance is attached to the

relationship between prices and earnings of U.S. stocks than foreign

stocks; the uniquely strict conditions imposed by the SEC for reporting

earnings are doubtless responsible for this. Moreover, the earnings

of foreign companies are often accounted for in ways that are not per

mitted in the U.S.)

The extent to which a company is known by foreign investors.

The best-known U.S. multi-nationals are popular with some foreign

portfolio managers because, as one of them said, "It's easier to explain

away a loss in a large well known U.S. company". Smaller U.S.

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companies will rarely attract significant foreign attention without a

directed public relations effort abroad. One relatively small U.S. chemical

company was reported to have made such an effort to make itself known in

England; while not listed among the top 600 U.S. companies held in U.S.

Common Trust Funds (as published in the May, 1975, issue of "Trusts

and Estates"), the company's stock was at that time probably in the top

20 American securities held by British institutions.

The liquidity of secondary markets for individual stocks.

Foreign investors are "leery of getting a stock dumped on us." They

are generally aware of the percent of outstanding shares held in a

given institutional account or even, in the case of the larger investors,

across all institutional accounts. With few exceptions, portfolio managers

tend to avoid narrow markets. In some cases, the investor has no choice.

In the Netherlands, for example, a permit from the central bank is re

quired in order to invest in U.S. shares traded over-the-counter; in

some countries, investors are restricted to securities listed on local

exchanges. Some Canadian, British and Swiss investors, though,

actually prefer the smaller companies recommended by "regional"

(non-New York) brokers.

SECTION V

THE MECHANISMS OF FOREIGN PORTFOLIO INVESTMENT

Foreign investors deal in the following U.S. investment instruments for their

portfolios:

Equities listed on a U.S. exchange only

Equities dually listed on U.S. and foreign exchanges

Equities traded over-the-counter (OTC)

Options

Externally issued corporate debt (Eurodollar obligations)

Internally issued corporate debt (marketable)

Internally issued corporate debt (privately placed)

This section discusses the mechanisms used by foreign portfolio investors

to acquire, hold and dispose of these various U.S. securities.

Foreign portfolio investors use the same channels to invest, for the most

part, as do U.S. portfolio managers. In order of relative size, these channels

for equities are the New York and American Stock Exchanges, regional exchanges,

the OTC market, and foreign exchanges which list U.S. securities.

42

Mechanisms for Equity Investments

Foreign investors use the following as intermediaries for equity transactions:

U.S. brokers, U.S. subsidiaries of foreign firms and the "stock exchange"

departments (or trading desks) of the foreign bank when dealing on an overseas

exchange. The point was made by some U.S. subsidiaries of foreign banks that,

although they had originally been created to serve as a captive vehicle to reduce

commission expenses for their parents, they had become independent brokerage

firms competing with U.S. brokers for the same clients. As the president of one

U.S. subsidiary said, "As I look at things, the only difference between us and

Merrill Lynch is that we have two shareholders and they have thousands."

With the trend towards increasing independence by the formerly "captive"

subsidiaries, more brokerage business is being directed by foreign portfolio

managers to U.S. brokers. The type of brokerage firm used is one which has

good research facilities, will service overseas accounts well, and has execution

expertise. In addition, many foreign investors seek firms who act as "block

2 positioners."

1

Except for Canadian firms, foreign owned brokers are prohibited from
becoming members of the New York Stock Exchange. However, they
are permitted to join regional exchanges. Under fixed commission rates,
they would execute orders, whenever possible, on a regional exchange,
thus reducing their execution costs.

2

A block positioner is a firm which will jcommit its own capital to acquire a portion of a securities position which is being sold. The firm then hopes to find other buyers for the securities on a large block basis, or sell their position through regular market channels at a price at least that which was paid by the broker.

Some foreign portfolio managers will enter all orders to buy and sell listed

securities to the New York Stock Exchange, while others use local exchanges,

notably the Swiss exchanges in Zurich and Geneva, as well as the Canadian

exchanges, in the case of Canadian investors.

The number of U.S. securities listed on foreign exchanges varies, but will

usually include the major U.S. corporations such as those included in the

Dow-Jones industrials index as well as multi-nationals doing business in the

host foreign country. In Switzerland, for example, a Swiss bank will "sponsor

a U.S. company, and will then be responsible for seeing that a reasonable market

is available. The "sponsor" will also arrange visits to Switzerland by executives

of the company.

Foreign investors were asked how they selected U.S. brokers to execute

orders. The results of a questionnaire on the subject are shown in Figure 4.

This chart shows that research capability and "quality of investment ideas" are

most important. Another important factor that was mentioned often was "the

broker's ability to invite us (the foreign bank) into key underwritings."

Another typical comment was, "We've had a long term relationship with that

firm, and wish to continue it."

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