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Elliott R. Morss
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Elliott Morss has spent most of his career teaching and working as an economic consultant to developing countries on issues of trade, finance, and environmental preservation. Dr. Morss received a B.A. from Williams College in 1960 and a Ph.D. in political economy from The Johns Hopkins... More
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  • Bet on Countries, Not Stocks
     
    Since then, the dollar has lost 10% against both the EUR and Japanese Yen. On June 11, I said buy commodities - http://www.morssglobalfinance.com/investment-strategies-iv/, and the IMF’s overall commodity price index has increased 5%.
     
    On June 11, I also made the specific suggestions shown in Table 1.
     
    Table 1. – Morss Recommendations June 11, 2009
     
    Emerging Markets Overall
    3 Yr. Return
    Ticker
    Vehicle*
    June 11- Dec. 4 Return
    BLDRS Emerg Mkts 50 ADR
    31.28
    ADRE
    ETF
    17.5%
    iShares MSCI Emerging Mkts
    29.96
    EEM
    ETF
    21.0%
     
     
     
     
     
    Latin America
     
     
     
     
    T. Rowe Price Latin America
    49.61
    PRLAX
    M
    41.0%
    iShares SP Latin 40
    45.1
    ILF
    ETF
    32.0%
     
     
     
     
     
    South Africa
     
     
     
     
    iShares MSCI South Africa
    29.5
    EZA
    ETF
    17.8%
     
     
     
     
     
    Asia
     
     
     
     
    iShares MSCI ex-Japan
    24.68
    EPP
    ETF
    26.5%
    Matthews  Pacific Tiger
    19.51
    MAPTX
    M
    22.2%
    Guinness Atkinson Asia
    26.45
    IASMX
    M
    19.5%
    * ETF =exchange traded fund; M = mutual fund.
     
    Now, I could crow about these results. After all, on an annualized basis, they are double the returns presented in this table. But this was a good period for all stock markets – even the S&P 500 was up 16.2%. And I would be the first to admit I am not a good predictor of stock market performance. After all, I completely missed last year’s global stock market collapse that caused a $36 trillion asset loss! And I, like better known investment gurus, personally found “my own inventive ways to lose money on a colossal scale during these last 15 months.” (Ben Stein, NYT, December 26, 2008). And finally, I am a firm believer in the random walk theory that says all information is immediately reflected in stock market prices so the results of stock market picks are pretty random (see Burton G. Malkiel, “A Random Walk Down Main Street”: W.W. Norton).
     
    However, I remain resolute in trying to apply economic logic to stock markets, so consider the following.
     
    Shouldn’t stock markets in countries growing rapidly increase more than markets in slower growing countries? If a country’s GDP is growing rapidly, the primary components of GDP – Consumption and Investment – also have to be growing rapidly. It should follow that the earnings/profits of companies publicly traded in the rapidly growing countries should also grow faster than companies listed in slower growing countries. And if earnings grow more rapidly, stock market prices should go up more rapidly.
     
    I think there is logic in this line of thinking, so let us explore it further.
     
    Table 2 presents the World Bank GDP growth projections for selected regions and countries. Look at China and India – a global recession in these countries means the growth rate falls from 10%+ to 5%+! And the country of South Africa outperforms Latin America and the Caribbean as a region. Now look at Euro, Japan, and the US – large downturns this year followed by meager growth next year, and that growth might be wishful thinking.
     
    Table 2. - World Bank GDP Growth Projections
     
    Area
    2007
    2008
    2009
    2010
    2011
     
     
     
     
     
     
    Asia/Pacific
    11.4
    8.0
    5.0
    6.6
    7.8
    China
    13.0
    9.0
    6.5
    7.5
    8.5
    India
    9.0
    6.1
    5.1
    8.0
    8.5
    South Korea
    5.1
    2.2
    -5.0
    2.5
    5.0
     
     
     
     
     
     
    South Africa
    5.1
    3.1
    -1.5
    2.6
    4.1
     
     
     
     
     
     
    Latin America/Carib.
    5.8
    4.2
    -2.2
    2.0
    3.3
    Argentina
    8.7
    6.8
    -1.5
    1.9
    2.1
    Brazil
    5.7
    5.1
    -1.1
    2.5
    4.1
    Chile
    4.7
    3.2
    -0.4
    2.7
    3.6
    Colombia
    7.5
    2.5
    -0.7
    1.8
    4.0
    Mexico
    3.3
    1.4
    -5.8
    1.7
    3.0
    Peru
    9.0
    9.8
    3.0
    4.3
    6.0
     
     
     
     
     
     
    Euro Region
    2.7
    0.6
    -4.5
    0.5
    1.9
    Japan
    2.3
    -0.7
    -6.8
    1.0
    2.0
    US
    2.0
    1.1
    -3.0
    1.8
    2.5
     
    These figures alone should raise questions about investing in the US, EURO, and Japan stock markets.
    But maybe the stock markets of certain countries are overpriced. The price/earnings ratio (P/E) is often used to gauge whether a stock is overpriced. So let us check on P/E ratios of countries. And if stock prices accurately discount country growth rates, should not the P/E ratios of countries with higher growth rates be higher that those with lower growth rates?
    Table 2. – Region/Country Projected Growth Rates and P/E Ratios
     
     
    Growth Rates
    2009
    Region/Country
    2009
    2010
    P/E Ratio
    Asia/Pacific
    5.0
    6.6
    21.71
    China
    6.5
    7.5
    24.63
    India
    5.1
    8.0
    20.52
    South Korea
    -5.0
    2.5
    13.79
     
     
     
     
    Latin America/Carib.
    -2.2
    2.0
    21.07
    Peru
    3.0
    4.3
    28.03
    Chile
    -0.4
    2.7
    18.15
    Colombia
    -0.7
    1.8
    24.32
    Brazil
    -1.1
    2.5
    19.38
    Argentina
    -1.5
    1.9
    7.38
    Mexico
    -5.8
    1.7
    17.53
     
     
     
     
    South Africa
    -1.5
    2.6
    16.61
     
     
     
     
    Canada
    -2.7
    1.5
    24.35
    US
    -3.0
    1.8
    17.55
    Euro
    -4.5
    0.5
    21.26
    Japan
    -6.8
    1.0
    28.68
     
    Table 2 lists countries by region by projected 2009 growth rates. And as can be seen, countries project to grow more rapidly (or decline by smaller amounts) do, for the most part, have higher P/E ratios than those with lesser growth prospects.
     
    Peter Lynch is considered one of the greatest investment gurus of all time (for more on gurus and how to invest using their strategies, see John Reese’s Validea.com). Lynch ran Fidelity’s Magellan Fund from 1977 to 1990. Its asset value grew from $20 million when he started was $13 billion when he left. Lynch liked to adjust the P/E ratio for the expected growth rate. His reasoning was that companies expected to grow should have higher P/E ratios. So he divided the P/E ratio by the projected growth rate (P/E/G). Projected growth rates and P/E/Gs are presented in Table 3.
     
    Table 3. – Growth Rates and P/E/G Ratios
     for Selected Regions/Countries
     
     
    Growth Rates
     
    Region/Country
    2009
    2010
    P/E/G
    India
    5.1
    8.0
    2.57
    China
    6.5
    7.5
    3.28
    Argentina
    -1.5
    1.9
    3.88
    South Korea
    -5.0
    2.5
    5.52
    South Africa
    -1.5
    2.6
    6.39
    Peru
    3.0
    4.3
    6.52
    Chile
    -0.4
    2.7
    6.72
    Brazil
    -1.1
    2.5
    7.75
    US
    -3.0
    1.8
    9.75
    Mexico
    -5.8
    1.7
    10.31
    Colombia
    -0.7
    1.8
    13.51
    Canada
    -2.7
    1.5
    16.23
    Japan
    -6.8
    1.0
    28.68
    Euro
    -4.5
    0.5
    42.52
     
    I think the P/E/G ratios in Table 3 give a great frame of reference for thinking about country investments. I like India and China. Argentina has great prospects but some governance problems to work out – see http://www.morssglobalfinance.com/argentina-effects-of-global-recession-and-future-prospects/. I like South Korea and South Africa for investments. Peru has had tremendous growth in recent years, but it is small…. Chile is well managed but in essence is a one export country (copper) see http://www.morssglobalfinance.com/chile-effects-of-global-recession-and-future-prospects/. Brazil’s prospects are better than any other Latin American country. And unlike China and India with high population densities and as a consequence are resource poor, Brazil is natural resource rich - http://www.morssglobalfinance.com/brazil-effects-of-global-recession-and-future-prospects/.
     
    Am I worried about the recent run up in stock markets and commodity prices? Yes, and I have written about it – see http://www.morssglobalfinance.com/prices-unemployment-and-the-global-economy/. But you will never get the timing just right. And it is too late in the recession to stay on the sidelines with any investment funds.
     
    Specific Investment Suggestions
     
    How do you “bet on countries” while at the same time bet against the dollar?
     
    1. To “bet on countries” use either ETFs or mutual funds. Do not use mutual funds unless the 3-5 year performance is significantly better than the appropriate ETF index fund. ETF fees are lower and they are easier to buy or sell than mutual funds. For more on ETFs, see Don Dion’s ETF Report - http://www.fidelityadviser.com/readme_etfr.html.
     
    2   To bet against the dollar, make sure that the ETF or mutual fund you choose does not hedge against currency fluctuations. A few do – for example see Longleaf shorting the Yen (and losing money) - http://www.longleafpartners.com/pdfs/09_q2.pdf. Just check - ask if the mutual fund or ETF hedges against currency fluctuations.
     
    Table 4 provides some specific investments suggestions.
     
    Table 4. – Investment Suggestions
     
    Emerging Markets Overall
    Ticker
    Vehicle*
    BLDRS Emerg Mkts 50 ADR
    ADRE
    ETF
     
     
     
    Latin America
     
     
    T. Rowe Price Latin America
    PRLAX
    M
    iShares MSCI Brazil
    EWZ
    ETF
     
     
     
    South Africa
     
     
    iShares MSCI South Africa
    EZA
    ETF
     
     
     
    Asia
     
     
    Matthews India
    MINDX
    M
    Matthews Korea
    MAKOX
    M
    iShares FTSE/Xinhua China 25
    FXI
    ETF
    Powershares India
    PIN
    ETF
    iShares MSCI South Korea
    EWY
    ETF
    iShares MSCI ex-Japan
    EPP
    ETF
    * ETF =exchange traded fund; M = mutual fund
     
     
     
     
    I am not an investment adviser and nothing I say should be taken as a recommendation to buy or sell an asset.

    Disclosure: i AM LONG IN ALL TAGS
    Tags: EWZ, EZA, FXI, PIN, EWY, EPP
    Dec 29 10:31 AM | Link | Comment!
  • Bet on Countries, Not Stocks
     
    Since then, the dollar has lost 10% against both the EUR and Japanese Yen. On June 11, I said buy commodities - http://www.morssglobalfinance.com/investment-strategies-iv/, and the IMF’s overall commodity price index has increased 5%.
     
    On June 11, I also made the specific suggestions shown in Table 1.
     
    Table 1. – Morss Recommendations June 11, 2009
     
    Emerging Markets Overall
    3 Yr. Return
    Ticker
    Vehicle*
    June 11- Dec. 4 Return
    BLDRS Emerg Mkts 50 ADR
    31.28
    ADRE
    ETF
    17.5%
    iShares MSCI Emerging Mkts
    29.96
    EEM
    ETF
    21.0%
     
     
     
     
     
    Latin America
     
     
     
     
    T. Rowe Price Latin America
    49.61
    PRLAX
    M
    41.0%
    iShares SP Latin 40
    45.1
    ILF
    ETF
    32.0%
     
     
     
     
     
    South Africa
     
     
     
     
    iShares MSCI South Africa
    29.5
    EZA
    ETF
    17.8%
     
     
     
     
     
    Asia
     
     
     
     
    iShares MSCI ex-Japan
    24.68
    EPP
    ETF
    26.5%
    Matthews  Pacific Tiger
    19.51
    MAPTX
    M
    22.2%
    Guinness Atkinson Asia
    26.45
    IASMX
    M
    19.5%
    * ETF =exchange traded fund; M = mutual fund.
     
    Now, I could crow about these results. After all, on an annualized basis, they are double the returns presented in this table. But this was a good period for all stock markets – even the S&P 500 was up 16.2%. And I would be the first to admit I am not a good predictor of stock market performance. After all, I completely missed last year’s global stock market collapse that caused a $36 trillion asset loss! And I, like better known investment gurus, personally found “my own inventive ways to lose money on a colossal scale during these last 15 months.” (Ben Stein, NYT, December 26, 2008). And finally, I am a firm believer in the random walk theory that says all information is immediately reflected in stock market prices so the results of stock market picks are pretty random (see Burton G. Malkiel, “A Random Walk Down Main Street”: W.W. Norton).
     
    However, I remain resolute in trying to apply economic logic to stock markets, so consider the following.
     
    Shouldn’t stock markets in countries growing rapidly increase more than markets in slower growing countries? If a country’s GDP is growing rapidly, the primary components of GDP – Consumption and Investment – also have to be growing rapidly. It should follow that the earnings/profits of companies publicly traded in the rapidly growing countries should also grow faster than companies listed in slower growing countries. And if earnings grow more rapidly, stock market prices should go up more rapidly.
     
    I think there is logic in this line of thinking, so let us explore it further.
     
    Table 2 presents the World Bank GDP growth projections for selected regions and countries. Look at China and India – a global recession in these countries means the growth rate falls from 10%+ to 5%+! And the country of South Africa outperforms Latin America and the Caribbean as a region. Now look at Euro, Japan, and the US – large downturns this year followed by meager growth next year, and that growth might be wishful thinking.
     
    Table 2. - World Bank GDP Growth Projections
     
    Area
    2007
    2008
    2009
    2010
    2011
     
     
     
     
     
     
    Asia/Pacific
    11.4
    8.0
    5.0
    6.6
    7.8
    China
    13.0
    9.0
    6.5
    7.5
    8.5
    India
    9.0
    6.1
    5.1
    8.0
    8.5
    South Korea
    5.1
    2.2
    -5.0
    2.5
    5.0
     
     
     
     
     
     
    South Africa
    5.1
    3.1
    -1.5
    2.6
    4.1
     
     
     
     
     
     
    Latin America/Carib.
    5.8
    4.2
    -2.2
    2.0
    3.3
    Argentina
    8.7
    6.8
    -1.5
    1.9
    2.1
    Brazil
    5.7
    5.1
    -1.1
    2.5
    4.1
    Chile
    4.7
    3.2
    -0.4
    2.7
    3.6
    Colombia
    7.5
    2.5
    -0.7
    1.8
    4.0
    Mexico
    3.3
    1.4
    -5.8
    1.7
    3.0
    Peru
    9.0
    9.8
    3.0
    4.3
    6.0
     
     
     
     
     
     
    Euro Region
    2.7
    0.6
    -4.5
    0.5
    1.9
    Japan
    2.3
    -0.7
    -6.8
    1.0
    2.0
    US
    2.0
    1.1
    -3.0
    1.8
    2.5
     
    These figures alone should raise questions about investing in the US, EURO, and Japan stock markets.
    But maybe the stock markets of certain countries are overpriced. The price/earnings ratio (P/E) is often used to gauge whether a stock is overpriced. So let us check on P/E ratios of countries. And if stock prices accurately discount country growth rates, should not the P/E ratios of countries with higher growth rates be higher that those with lower growth rates?
    Table 2. – Region/Country Projected Growth Rates and P/E Ratios
     
     
    Growth Rates
    2009
    Region/Country
    2009
    2010
    P/E Ratio
    Asia/Pacific
    5.0
    6.6
    21.71
    China
    6.5
    7.5
    24.63
    India
    5.1
    8.0
    20.52
    South Korea
    -5.0
    2.5
    13.79
     
     
     
     
    Latin America/Carib.
    -2.2
    2.0
    21.07
    Peru
    3.0
    4.3
    28.03
    Chile
    -0.4
    2.7
    18.15
    Colombia
    -0.7
    1.8
    24.32
    Brazil
    -1.1
    2.5
    19.38
    Argentina
    -1.5
    1.9
    7.38
    Mexico
    -5.8
    1.7
    17.53
     
     
     
     
    South Africa
    -1.5
    2.6
    16.61
     
     
     
     
    Canada
    -2.7
    1.5
    24.35
    US
    -3.0
    1.8
    17.55
    Euro
    -4.5
    0.5
    21.26
    Japan
    -6.8
    1.0
    28.68
     
    Table 2 lists countries by region by projected 2009 growth rates. And as can be seen, countries project to grow more rapidly (or decline by smaller amounts) do, for the most part, have higher P/E ratios than those with lesser growth prospects.
     
    Peter Lynch is considered one of the greatest investment gurus of all time (for more on gurus and how to invest using their strategies, see John Reese’s Validea.com). Lynch ran Fidelity’s Magellan Fund from 1977 to 1990. Its asset value grew from $20 million when he started was $13 billion when he left. Lynch liked to adjust the P/E ratio for the expected growth rate. His reasoning was that companies expected to grow should have higher P/E ratios. So he divided the P/E ratio by the projected growth rate (P/E/G). Projected growth rates and P/E/Gs are presented in Table 3.
     
    Table 3. – Growth Rates and P/E/G Ratios
     for Selected Regions/Countries
     
     
    Growth Rates
     
    Region/Country
    2009
    2010
    P/E/G
    India
    5.1
    8.0
    2.57
    China
    6.5
    7.5
    3.28
    Argentina
    -1.5
    1.9
    3.88
    South Korea
    -5.0
    2.5
    5.52
    South Africa
    -1.5
    2.6
    6.39
    Peru
    3.0
    4.3
    6.52
    Chile
    -0.4
    2.7
    6.72
    Brazil
    -1.1
    2.5
    7.75
    US
    -3.0
    1.8
    9.75
    Mexico
    -5.8
    1.7
    10.31
    Colombia
    -0.7
    1.8
    13.51
    Canada
    -2.7
    1.5
    16.23
    Japan
    -6.8
    1.0
    28.68
    Euro
    -4.5
    0.5
    42.52
     
    I think the P/E/G ratios in Table 3 give a great frame of reference for thinking about country investments. I like India and China. Argentina has great prospects but some governance problems to work out – see http://www.morssglobalfinance.com/argentina-effects-of-global-recession-and-future-prospects/. I like South Korea and South Africa for investments. Peru has had tremendous growth in recent years, but it is small…. Chile is well managed but in essence is a one export country (copper) see http://www.morssglobalfinance.com/chile-effects-of-global-recession-and-future-prospects/. Brazil’s prospects are better than any other Latin American country. And unlike China and India with high population densities and as a consequence are resource poor, Brazil is natural resource rich - http://www.morssglobalfinance.com/brazil-effects-of-global-recession-and-future-prospects/.
     
    Am I worried about the recent run up in stock markets and commodity prices? Yes, and I have written about it – see http://www.morssglobalfinance.com/prices-unemployment-and-the-global-economy/. But you will never get the timing just right. And it is too late in the recession to stay on the sidelines with any investment funds.
     
    Specific Investment Suggestions
     
    How do you “bet on countries” while at the same time bet against the dollar?
     
    1. To “bet on countries” use either ETFs or mutual funds. Do not use mutual funds unless the 3-5 year performance is significantly better than the appropriate ETF index fund. ETF fees are lower and they are easier to buy or sell than mutual funds. For more on ETFs, see Don Dion’s ETF Report - http://www.fidelityadviser.com/readme_etfr.html.
     
    2   To bet against the dollar, make sure that the ETF or mutual fund you choose does not hedge against currency fluctuations. A few do – for example see Longleaf shorting the Yen (and losing money) - http://www.longleafpartners.com/pdfs/09_q2.pdf. Just check - ask if the mutual fund or ETF hedges against currency fluctuations.
     
    Table 4 provides some specific investments suggestions.
     
    Table 4. – Investment Suggestions
     
    Emerging Markets Overall
    Ticker
    Vehicle*
    BLDRS Emerg Mkts 50 ADR
    ADRE
    ETF
     
     
     
    Latin America
     
     
    T. Rowe Price Latin America
    PRLAX
    M
    iShares MSCI Brazil
    EWZ
    ETF
     
     
     
    South Africa
     
     
    iShares MSCI South Africa
    EZA
    ETF
     
     
     
    Asia
     
     
    Matthews India
    MINDX
    M
    Matthews Korea
    MAKOX
    M
    iShares FTSE/Xinhua China 25
    FXI
    ETF
    Powershares India
    PIN
    ETF
    iShares MSCI South Korea
    EWY
    ETF
    iShares MSCI ex-Japan
    EPP
    ETF
    * ETF =exchange traded fund; M = mutual fund
     
     
     
     
    I am not an investment adviser and nothing I say should be taken as a recommendation to buy or sell an asset.

    Disclosure: i AM LONG IN ALL TAGS
    Tags: EWZ, EZA, FXI, PIN, EWY, EPP
    Dec 29 10:31 AM | Link | Comment!
  • Who Controls Global Capital?
    Road Maps of the Financial Industry
     
    by Dr. Elliott R. Morss
     
    Executive Summary
     
    Global financial assets lost $50 trillion in value in the credit freeze/global recession - http://www.morssglobalfinance.com/no-predictions-just-data/. They have made back $28 trillion. Where do the assets come from and how are they being invested?
     
    The financial world has changed dramatically in the last two decades. A new industry of investment managers has emerged. It controls vast pools of funds collected by banks, pension funds, insurance companies, and mutual funds. Associated with this, new strategies and instruments to buy and sell risk have evolved into a giant financial industry of its own. This article describes these new financial industries - quantitatively and qualitatively – and explores their impact on global capital flows. It provides qualitative and quantitative road maps of the global financial industry.
     
    Prologue
     
    For the last 40 years, I have spent most of my time working in developing countries, first as a staffer at the International Monetary Fund and later as a consultant and private investor. I have always been interested in global power.
     
    In “The New Global Players: How They Compete and Collaborate”, I presented my conception on what the post Cold War global power structure would be.[1] The essential point was that nation-states no longer ruled the world alone but had been joined by multinational corporations, international organizations, and special interest groups (SIGs)[2] as global powers.
     
    The power structure outlined in that 1991 article has stood up well. And my interest has increasingly focused on global power and finance. In 1998, a conference was held on
    multinational organizations that resulted in a book edited by Alfred Chandler and Bruce Mazlish[3] in which I co-authored an article on global finance[4] and another article on global elites[5].
    I concluded at that time that real global power and finance were closely aligned and poorly understood. I hoped to develop “road maps” of global finance: who were the major players and what did they do? My findings are presented below.
     
    I. But First: A Brief Historical Review
     
    In order to understand today’s financial structure, it is useful to briefly review the changes in global financial structures and institutions that have occurred since men lived in caves. Cave living was significant, because launched one of the two major “product lines” of the financial industry – insurance/risk adjustment. Living in caves reduced the risks associated with weather and attacks by dangerous animals.
     
    When men lived in caves, there was no trade because there were no “production surpluses” to trade. Initially, all trade was one good for another, or “barter”. Money or “a medium of exchange” came along later in recognition that barter was often inconvenient. Precious metals served as the first form of money. From there, we evolved to gold coins, then paper money and coins with little intrinsic value, to plastic (credit cards).
     
    Banks grew up as vehicles to transfer unspent monies (savings) to investors. These transfers were critical in early times to allow shippers to “stock up” prior to voyages taking six months or more. Commercial banks served as the first institutional vehicle to effectively mobilize significant amounts of saving for investments.
     
    The financial world has changed dramatically in the last two decades. An entirely new industry has emerged. It controls vast pools of funds collected by banks, brokers, mutual funds, wealth managers, pension funds and insurance companies. Associated with these “collectors”, a new industry of consultants has grown up to advise on how these funds should be invested.
     
    This new financial industry is described below from three distinct viewpoints, an “institutional” one that traces savings through institutions to invesments, a “borrowing roadmap that illustrates who borrows and what happens to the debt, and as a “risk adjustment process”.
     
    II. The Three Roadmaps
     
    a. The Institutional Roadmap – Who are the Financial Players? How Does It Work?
     
    In essence, here is how the global finance industry works. Income is earned; collectors pass it to intermediaries who in turn select investors who choose the vehicles.
     
    Income Recipients►Collectors►Intermediaries►Investors►Vehicles
     
    More details are given in the following table.
     
    The Global Road Map of Finance - Institutional Investments
    Income
    Finance
    Recipients
    Collectors
    Intermediaries
    Investors
    Vehicles
    Individuals
    Banks
    Collectors
    Collectors
    Direct
     
        Commercial Banks
     
     
     
    Institutions
        Savings Banks
    Consultants
    Intermediaries
    Stocks
        For-Profit
        Credit Unions
     
     
        Direct (via Brokers)
        Financial
     
    Investment Banks
    Others
        Mutual Funds
        Non-Profit
    Stock Brokers
     
       Hedge Funds
     
     
     
    Risk Adjusters
       Private Equity
    Banks
    Governments
    Mutual Funds
     
       Venture Capital
        Checking
     
     
     
     
        Savings
     
    Wealth Managers
     
     
        CDs
     
     
     
     
     
     
    Insurance
     
     
    Secondary
     
        Life
     
     
    Markets
     
        Casualty
     
     
     
     
     
     
     
     
     
    Pensions
     
     
     
     
        Private
     
     
     
     
        State/Local
     
     
     
     
        Federal
     
     
     
     
     
    The “Income Recipients”, “Collectors”, “Intermediaries”, “Investors”, and “Investment Vehicles”are the key players in the new global financial industry. Individuals have funds for investment after paying for consumption and taxes out of income. Institutions may have investment funds. If governments run surpluses, they also have funds for investments. “Collectors” are good at marketing: convincing individuals and institutions to give them their money to invest. They aggressively pursue income recipients for their funds. They give the impression that they will invest your funds. But often they do not – their expertise is in getting funds, and they often find others to invest these monies, the “Intermediaries”. In recent years, this has spawned an entirely new Industry – that include the “Consultants” and “Risk Adjusters”. These advisors tell the collectors both how to structure their investments and which investment managers to use.
     
    A Caveat
     
    In one sense, the financial industry is like the fast food business: you start with a hamburger, taco, pizza or some other specialty food. But from there, you broaden into
    other food lines to get more customers. So too with the financial industry: you start as bankers, insurers, brokers, mutual funds, and then move laterally into other financial areas in hopes of becoming the “supermarket of finance”. This blurs some of the dividing lines in the road map.
     
    b. The Borrowing Road Map
    The current economic crisis had its genesis in sub-prime mortgages. What happened can be best understood by looking at the global road map of borrowing.
     
    The Global Road Map of Finance - Borrowing
     
     
     
    Borrowing
    Borrowers
    Lenders
    Guarantors
    Vehicles
    Individuals
    Banks
    Banks
    Mortgages
     
     
     
     
    Institutions
    Mortgage
    Insurance
    Credit Cards
        For-Profit
    Companies
    Companies
     
        Financial
     
     
    Other
        Non-Profit
    Countries
    Government
    Loans
     
     
    Agencies
     
    Governments
     
     
     
     
    c. The Risk Adjustment View
     
    It is also possible to understand the financial industry as a mechanism to adjust the risk profile of assets. Virtually every financial transaction involves a risk adjustment of one sort or another. For example, when you deposit cash in a bank, your risk profile changes in that your cash becomes a bit more physically secure but at the same time, your ability to use that money becomes dependent on the financial well-being of the bank.
     
    The financial industry can be seen as the emergence of firms that change the risk of investors. A "risk adjuster" can be defined as one who changes the risk profile of any investment. The best-known forms of risk brokerage are insurance and pensions. In these cases, the client pays a commission to the insurance companies and pension funds to reduce risk. There are other institutions that buy risk. For example, some hedge funds pay risk-adjusters to provide them with high-risk packages.
     
    Derivatives have become a well-known financial term. A financial “derivative” is nothing more that an existing agreement or contract converted to a new contract with a different risk profile. For example, suppose Lufthansa enters into an agreement to buy Boeing jets for delivery in five years. Lufthansa will budget the payment in EURs, but Boeing will want payment in U.S. dollars, and the exchange rate between these currencies will change in five years. Lufthansa can pay some institution a fee to guarantee today’s exchange rate. The institution would write Lufthansa a derivative contract stating that Lufthansa’s EUR payment will be converted to U.S. dollars at today’s exchange rate. The exchange rate fluctuation risk would thereby be removed from Lufthansa.
     
    Another example of the expansion of risk adjustment are the secondary markets for mortgages. These were initially created by government bank regulators to reduce the risks banks face as a result of interest rate changes. Banks used to make most of their money on the difference in interest rates they pay on deposits and the interest rate they can get on loans – the spread. If they make a 30-year loan at today’s lending rate and interest rates rise, their spread will fall. The secondary markets allow them to sell their new mortgages off and make money on a commission they make on writing up the initial mortgage. This removes the interest rate change risk for banks.
     
    The Global Road Map of Finance – Risk Adjustment
     
     
    Risk
    Risk Adjustment
    Clients
    Risk
    Adjusters
    Vehicles
    Individuals
    Weather
    Mutual
    Caves
     
     
    Funds
     
    Institutions
    Animals
     
    Cages
        For-Profit
     
    Insurance
     
        Financial
    Health
    Companies
    Insurance
        Non-Profit
     
       Life
     
     
    Property
       Casualty
    Mutual
    Governments
     
     
    Funds
     
    Economic
    Pension
     
     
    Fluctuations
    Funds
    ETFs
     
       Interest
     
     
     
       Rates
    Hedge
    Options
     
     
    Funds
     
     
     Exchange
     
    Hedges
     
     Rates
    Commercial
     
     
     
    Banks
    Swaps
     
       Stock
     
     
     
       Prices
    Government
    Derivatives
     
     
    Agencies
     
     
    Leverage
     
     
     
     
    Investment
     
     
     
    Banks
     
     
    Adjustable rate mortgages is another example of a risk adjustment vehicle. The Federal regulators introduced them to protect banks from the risks of interest rate changes. There has been a dramatic increase in risk adjustment activities over the last 15 years to a point that risk adjustment is now the largest industry in the world. Much of this activity has taken place to manage the risk associated with stock market investments, foreign exchange or interest rates changes. Only $3 trillion in currency trading is needed to finance the world's imports and exports of goods and services annually. There is $1.3 trillion in currency trading daily, with much of this involving risk brokering. By the end of 2004, the Bank for International Settlements estimated that derivative contracts outstanding were $248 trillion. By contrast, the combined value of bonds, equities and bank assets for North America, Japan, and European Common Market countries was only $68 trillion.
     
    We now turn back to a more detailed examination of the institutional road map.
     
    III. The Institutional View In Detail
     
    a. Income Recipients
     
    Who are the income recipients, and what are their income sources?
     
    Income Recipients
    Income Sources
    Individuals
        Wages
      
        Interest
      
        Dividends
      
        Capital gains
      
     
    Institutions
     
        For-Profit
     
            Insurance Companies
        Premiums
            Other Financial
        Fees, various
            Other Non Financial
       
            Other
     
        Non-Profit
     
            Pensions   
        Pension contributions
            Other non-profit
        Various
        Government
        Taxes, fees
    Rest of World
        Various
     
    We only have detailed Income Recipient information on the United States which is presented below.[6] The first table provides details on individuals’ annual investments for the last few years. They deposit money in banks and mutual funds. Note that on a net basis, individuals have been selling stocks they have bought directly (through brokers). They also put money in their pension funds and pay fees to insurance companies.
     
     
    US: Significant Financial Activities of Individuals*
    (bil. US dollars)
    Item
    2004
    2005
    2006
    2007
    Personal Income
    9,727
    10,301
    10,983
    11,659
    Assets: Increase in -
     
     
     
     
     Bank Deposits
    409
    337
    472
    427
     Mutual Funds
    160
    274
    402
    536
     Corporate Equities, Directly Held
    -269
    -467
    -761
    -989
     Corporate and Foreign Bonds
    44
    -25
    194
    66
     Government Securities and Loans
    144
    -11
    -97
    247
     Life Insurance Fees
    33
    16
    66
    27
     Pension Fund Payments
    288
    238
    198
    124
     
     
     
     
     
    Liabilities: Increase in -
     
     
     
     
     Mortgages
    940
    1,029
    988
    655
     Consumer Credit
    115
    95
    104
    132
    * These data include a small amount for non-profit organizations.
     
    The second table on individuals provides data on their total assets and liabilities at the end of 2005. Their largest asset holding is their real estate, followed by their pension fund assets and bank deposits. Even though they have been net liquidators of stocks held directly, they still own more stocks directly than they do through mutual funds. Their liabilities are also noteworthy. They had $41 trillion in mortgage debt and almost $10 trillion in credit (mostly credit card) debt.
     
    US: Significant Balance Sheet Items of Individuals
    (billions of US dollars)
    Assets
    2007 
    Real Estate
    80,862
    Pension Fund Reserves
    51,079
    Mutual Funds
    24,984
    Bank Deposits
    28,443
    Proprietors' Investment in Unincorporated Business
    30,896
    Corporate Equities, Directly Held
    23,377
    Consumer Durable Goods
    15,907
    Government Securities
    8,238
    Life Insurance Reserves
    4,769
     
     
    Liabilities
     
    Home Mortgages
    41,150
    Consumer Credit
    9,882
     
    Like individuals, businesses earn income that can be invested. Again, we only have detailed data on US businesses.
     
    US: Significant Non-Financial Business Activities
    (in billions of US dollars)
    Description
    2003
    2004
    2005
    2006
    Income before Taxes
    1,714
    2,283
    2,886
    3,145
    Assets: Increase in - 
     
     
     
     
     Bank Deposits
    329
    173
    352
    -97
     Mutual Funds
    -60
    62
    108
    203
     
     
     
     
     
    Liabilities: Increase in -
    304
    751
    925
    1,398
     Corporate Equity Issues
    139
    296
    233
    178
     Loans
    166
    455
    692
    1,220
     
     
     
    US: Non-Financial Business
    Significant Balance Sheet Items
    (in billions of US dollars)
    Description
    2006
    Assets
    31,077
    Bank Deposits
    2,949
    Mutual funds
    1,442
    Direct Investment
    2,327
     
     
    Liabilities
    32,955
    Bonds
    6,423
    Loans
    5,163
    Mortages
    6,537
    Corporate Equity
    14,646
     
    Most governments have debt, so any government surpluses are used to pay down their debts. However, there is a small number of governments who continually run large surpluses (mostly because of energy exports). Some of these countries have set up government investment funds (called sovereign funds). The largest sovereign funds are listed in the following table. Not included in this table are foreign government institutions (mostly Central Banks) that are buying up US government debt to keep the value of the US dollar from following futher. By the end of 2007, these financial institutions owned $773 billion, or 15.4% of all US Treasury debt.[7]
     
    Sovereign Funds
     
     
    Amount
    Year
    Fund
    Fund
    (in bil. US$)
    Established
    Per Capita
    UAE: Abu Dhabi Investment Authority
    875
    1976
    194,617
    Singapore: GIC
    330
    1981
    76,283
    Singapore: Tamasek
    159
    1974
    36,801
    Singapore: Total
    489
     
    113,084
    Norway: Government Pension Fund - Global
    380
    1996
    81,341
    Saudi Arabia: various
    300
    na
    12,209
    Kuwait: Reserve Fund for Future Generations
    250
    1953
    93,041
    China: China Investment Corporation
    200
    2007
    152
    Hong Kong:: Monetary Authority
    140
    1998
    20,056
    Russia
    127
    2003
    873
    Libya: Oil Reserve Fund
    50
    2005
    8,282
    Qatar: Qatar Investment Authority
    50
    2005
    61,501
    Algeria: Fond de Regulation des Recettes
    43
    2000
    1,278
    US: Alaska Permanent Fund Corporation
    38
    1976
    56,712
    Brunei: Brunei Investment Authority
    30
    1983
    80,214
    Other
    44
     
     
    Total
    3,505
     
     
       of which oil and gas related
    2,103
     
     
                Source: “Asset-backed insecurity”, The Economist, January 19,2008 and various articles by
                Stephen Jen of Morgan Stanley
     
    Jen estimates that by 2015, sovereign funds will have grown to $12 trillion. He also believes that by then, sovereign funds from the non-oil exporters will be equivalent to those of the oil exporters.
     
    b. Collectors
     
    In the last 30 years, commercial banks have lost their monopoly position as the repository for individual and institutional funds. Today, pension funds, insurance companies, mutual funds, securities dealers have joined commercial banks as the primary
    “collectors” of global savings. Who are the leading Collectors, and how do they market themselves? The leading U.S. collectors are presented in the following table.
     
    Assets of U.S. Financial “Collectors”
    (US$ billions, end of year)
    Sector
    2006
    Banks
     
    Commercial banking
    10,204
    Savings institutions
    1,714
    Credit unions
    719
         Total
    12,637
     
     
    Stock Brokers
    2,742
     
     
    Mutual Funds
    9,700
     
     
    Pensions
     
    Private pension funds
    5,558
    State and local govt. retirement funds
    2,979
    Federal govt. retirement funds
    1,142
         Total
    9,679
     
     
    Insurance
     
    Life insurance companies
    4,708
    All other insurers
    1,365
         Total
    6,074
    Source: Board of Governors, Federal Reserve System
     
    Insurance companies take in fees and pay out when events they are insuring against actually occur. In this process of collecting fees, the insurance companies have amassed large asset pools estimated to be $14 trillion globally. These assets will continue to grow as insurance services expand in developing countries.
     
    Like insurance, the pension fund industry has grown dramatically in recent years, and its growth is likely to continue. Funds are accumulated as money is withdrawn regularly from salaries. Today, global pension fund assets exceed $13 trillion.
     
    The more publicly accessible stock markets for trading the shares of public companies have blossomed not only in the West, but increasingly in emerging economies. Today, the global value of stock markets exceeds $23 trillion. Until the 1980s, stock brokers/securities firms served as the primary agents for the buying and selling of stocks. In recent years, brokers have become less important as the popularity of mutual funds has increased. U.S. mutual fund investments exceed $7 trillion, suggesting that their investments are approximately 50% of U.S. stock exchange assets. There are
    about 8,000 companies with listings on the three major U.S. stock exchanges. Remarkably, there are more than 21,000 mutual funds buying and selling those stocks.
     
    The large money pools generated by these institutions have to be invested. Many of the organizations collecting these funds view themselves as marketers and prefer to pay others to invest their money. So they also pay a rapidly growing cadre of advisers to tell them which financial managers to use. The financial management business is highly competitive, and success is often measured by quarterly to six-month rates of returns.
     
     
    Vehicles
    2003
    2004
    2005
    2006
    2007
    Other Finance
    11,338
    10,833
    12,547
    14,305
    16,471
    Mutual funds
    4,135
    3,638
    4,654
    5,436
    6,049
    Issuers of asset-backed securities
    1,732
    1,945
    2,158
    2,574
    3,264
    Security brokers and dealers
    1,466
    1,335
    1,613
    1,845
    2,127
    Money market mutual funds
    2,241
    2,224
    2,016
    1,880
    2,007
    Real estate investment trusts
    76
    102
    136
    253
    330
    Exchange-traded funds
    83
    102
    151
    226
    296
    Closed-end funds
    140
    151
    206
    246
    271
     
     
     
     
     
     
    Banking
    8,121
    8,679
    9,291
    10,210
    11,110
    Commercial banking
    6,829
    7,329
    7,825
    8,560
    9,320
    Savings institutions
    1,291
    1,350
    1,466
    1,650
    1,789
     
     
     
     
     
     
    Pension/Retirement Finds
    7,115
    6,502
    7,823
    8,511
    8,896
    Private pension funds
    4,048
    3,677
    4,520
    4,915
    5,120
    State and local government employee retirement funds
    2,207
    1,931
    2,344
    2,572
    2,702
    Federal government retirement funds
    860
    894
    959
    1,024
    1,075
     
     
     
     
     
     
    Insurance
    4,085
    4,275
    4,833
    5,293
    5,595
    Life insurance companies
    3,225
    3,335
    3,773
    4,130
    4,351
    Property-casualty insurance companies
    860
    940
    1,060
    1,162
    1,244
     
     
     
     
     
     
    Government
    4,665
    4,948
    5,344
    5,501
    5,581
    Government-sponsored enterprises
    2,309
    2,549
    2,794
    2,883
    2,819
    State and local governments
    1,748
    1,800
    1,908
    2,015
    2,168
    Federal government
    607
    599
    641
    602
    593
     
     
     
    c. Intermediaries
     
    In short, extremely large pools of money are being invested by these new financial managers. These managers are not well known (this is in part because the “collectors” do not want clients to know they get others to invest their money). The investors of these large money pools, the new investment managers, are the primary drivers of global investments. The collectors use advisors to help them with their investment decisions. Partly, this is to insure they are in compliance with Federal laws - Congress recently enacted a new pension law that runs more than 900 pages. There is also the need to choose investment managers, and many of the consultants have developed rating criteria for the managers. The following table lists the top 20 consultants as measured by global institutional tax-exempt assets.
     
     
    Largest Global Consultants, 2005
    ($ millions)
    Consultant
    Assets 
    Russell Investment Group*
    $1,726,790
    Watson Wyatt Investment
    $1,500,000
    Cambridge Associates
    $925,000
    Callan Associates
    $900,000
    R.V. Kuhns & Associates
    $782,851
    Ennis Knupp + Associates
    $737,000
    Strategic Investment Solutions
    $706,145
    Mercer Investment Consulting**
    $668,907
    Pension Consulting Alliance
    $625,576
    Wilshire Associates
    $620,000
    Hewitt Associates
    $495,000
    CRA RogersCasey
    $325,000
    Richards & Tierney
    $306,082
    API Asset Performance
    $300,000
    Evaluation Associates
    $265,000
    Rocaton Investment Advisors
    $250,000
    Independent Fiduciary
    $205,967
    New England Pension
    $205,000
    Angeles Investment Advisors
    $194,000
    Summit Strategies Group
    $110,000
     
     
    d. Investors
     
    Typically, a collector will either develop an in-house investment capability or hire one or more outside investment firms to invest their funds. This chapter will discuss the leading “Investment Managers”, how they market themselves and how they choose to invest the monies they manage. The following table list the ten largest investment managers globally ranked by institutional assets under management.
     
    Largest Global Asset Managers
     Manager
    Assets ($ millions)
    State Street Global
    $1,315,888
    Barclays Global
    $1,172,724
    Fidelity Investments
    $809,656
    Mellon Financial
    $551,204
    AIG Global Investment
    $494,622
    Wellington Mgmt.
    $469,259
    Deutsche Asset Mgmt.
    $454,757
    JPMorgan Asset Mgmt.
    $449,348
    Northern Trust Global
    $411,755
    Vanguard Group
    $398,751
    Source: Pensions & Investments
     
     
    Subsidiary industries have emerged to support the new financial world. The collectors need ratings to choose investment managers, so a group of investment manager performance raters has sprung up. So too, the investment managers need help in finding
    new money to manage. As a result, a group of firms has been created to assist investment managers to find new funds to invest.
     
    The Frank Russell Company both manages money for institutions and offers a rating service on other financial management companies. Operating in more than 30 countries, it helps more than 600 international clients choose investment managers. Its clients manage $2.4 trillion, making it the largest firm of its type in the world.
     
    Despite its size and influence, few people have heard of the Russell Company. The same can be said for Wellington Management (a firm managing about $470 billion), General Atlantic Partners (probably the largest venture capital company in the world with a portfolio in excess of $6 billion), and Stark Investments (one of the largest hedge funds in the world).
     


    [1] Elliott R. Morss, “The New Global Players: How They Compete and Collaborate”, World Development, vol. 19, no. 1, pp. 55-64, 1991.
    [2] SIGs are cause-driven groups where their cause is not primarily to make money. SIGs include NGO/civil society groups as well as more radical, dictatorial groups that use peaceful and violent means, such as terrorism, to achieve their objectives.
    [3] Alfred D. Chandler and Bruce Mazlish, Leviathans: Multinational Corporations and the New Global History, Cambridge: Cambridge University Press, 2005
    [4] Zhu Jia Ming and Elliott R. Morss, “The Financial Revolutions of the Twentieth Century”, published in Chandler and Mazlish, op.cit..
    [5] Bruce Mazlish and Elliott R. Morss, “Is There A Global Elite”, published in Chandler and Mazlish, op. cit..
    [6] The source of the US data in this and following tables comes from the Board of Governors of the Federal Reserve System’s “Flow of Funds” accounts.
    [7] Board of Governors, Federal Reserve, Flow of Funds, Table L-209.
    Dec 29 10:19 AM | Link | Comment!
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