Investors know that money moves to the countries where it can get the highest returns. The last few years have shown just how intertwined are the world's equity markets, but also the obstacles that have to be hurdled before a truly international market exists. The global bull market of the last five years has seen the market capitalization of the world's stock exchanges grow to more than $8 trillion, up 168 percent, according to the Securities Industry Association, a trade group.
Furthermore, the dollar value of equities traded around the world has grown 310 percent, to almost $3.5 trillion, and the Eurobond market has reached $3 trillion a year, the association noted.
Technology, stable economies, market deregulation, the opening of the United States to foreign securities firms, and liberalized regulations have contributed to this international equity growth.
``You can sit in Bern and buy in Paris,'' said Robert D. Hormats, vice-chairman of Goldman Sachs International Corporation, at a conference sponsored by the securities association last week. ``An investor can look around the world to see where he can get better yields and price-earnings ratios.''
European investors have been investing overseas for decades. Only in the last decade have US traders begun doing so. Mr. Hormats said large sums of American money have been invested in the Dutch, Spanish, and Canadian markets, reflecting a search for value and a ``recognition that the US equity market is not the only equity market in the world.'' Japan is the world's second-largest securities market.
Buying overseas gives a portfolio diversity. ``We're seeing substantial recognition to look internationally for hedging and diversification,'' Hormats noted. ``Foreign investors will continue to be interested in the US ... and it's going to be hard for companies not to look to the international markets.'' He expects that within the next 10 years, assets in US pension funds will reach $2 trillion. Today, American institutions have invested $50 billion abroad.
Foreign exchanges also have offered terrific returns. Nine foreign stock exchanges have outperformed the US markets so far this year. Or, as Lilia C. Clemente, chairman of Clemente Capital Inc., says, ``If you're not investing globally, you're missing 65 percent of the market.'' She says the rewards of investing in emerging countries - such as Brazil, India, Taiwan, Korea, Spain, and Mexico - have outweighed the risks. An international fund is always subject to the country's political and economic conditions, and therefore Mrs. Clemente advises investors to always watch the currency.
The move to global markets and 24-hour-a-day trading is moving ahead, although with some glitches. Terms and rules in one country do not always mean the same thing in another. ``US expertise doesn't necessarily mean worldwide expertise,'' observed Joel Press, a partner at Oppenheim, Appel, Dixon & Co. He noted, for example, that many countries do not have provisions for swap trades, or the exchanging of one security for another. ``Firms are expanding activity into new markets.... You need the proper people trading your portfolio,'' Mr. Press said.
Another hitch is the difference in regulations among countries. Press said the US has the most sophisticated supervision procedures of any country. Other markets have less regulation. One ramification of this is that brokerages and investment firms have developed country funds, in which a fund manager buys securities in foreign markets. This is considered investing offshore. One of the drawbacks of such investing is that the foreign securities are not protected by US regulations. In some cases investors cannot get full disclosure about these funds. ``US regulators need to understand that capital will seek the highest risk-adjusted rate of return at the lowest transaction cost,'' pointed out Joseph Grundfest, a commissioner at the Securities and Exchange Commission. This has been a relatively recent development, he said, that the locus of the transaction does not need to be the place where the transactions happen.
``Why kick business out of Manhattan?'' Mr. Grundfest asked. ``If we're smart, this is good news. If we adapt to the marketplace,'' by providing onshore-offshore investment opportunities, ``we may be the lowest cost provider. We must recognize that we can't control the entire world's capital markets.''
Clearance of transactions and settlement of accounts are areas that also must be smoothed out. ``Settlement and clearance have not kept pace with technology,'' pointed out David Mann, vice-president and group manager of the Global Support Group for Merrill Lynch, Pierce, Fenner & Smith Inc.
``To clear a transaction internationally probably costs 100 times what it does to clear nationally,'' estimated Roger Birk, chairman of the International Securities Clearing Corporation, which is working to establish connections with central clearing and depository organizations abroad.
Because no single depository system exists to handle international trades, brokerages and traders must develop relationships with local banks. ``You're dealing with different time zones, and cultural and language differences. There is no standard by which one can benchmark, so each market has its own settlement character,'' Mr. Mann pointed out.
``Today is tomorrow in Japan,'' he said. So how is a deal settled when Hong Kong requires a one-day settlement of an account, France settles on the last business day of the month, and Australia likes to settle as soon as possible? The US has fixed settlement dates.
Extended settlement difficulties have occurred in England, Italy, and Spain, as some transactions have required transfers and reregistration of securities.
Many developed markets are looking to establish a central depository system, which could make settlement easier and lead to the possibility of linking the major markets, Mann said.
Automated trade instructions may ease the problems of international settlement and clearance. Two companies offer products that can take the automated order feed from the broker or back office system and link it to the systems of the agent bank. ``No one has to touch it, because it moves electronically,'' Mann said.
Another measure to speed the flow would be the expansion of the Depository Trust Company identification number system. ``Currently, on the US side, everyone who needs to see the transaction can see that. You have to involve people on the international side, all the participants in the trade,'' Mann said. This company is the central repository where stock and bond certificates change hands.
For the record, the Dow Jones industrial average fell a record 158.78 points last week to close at 2,482.21.