Gary Brinson an Expert on Global Investing

Gary Brinson is a staunch advocate of asset allocation techniques and a pioneer of global investing. In 1974, the firm now known as Brinson Partners (then a unit of First Chicago) was one of the first to invest overseas. Brinson led a management buyout of the unit in 1989 and the firm was later acquired by Swiss Bank Corporation. The latter has since merged with Union Bank of Switzerland and as a result, Brinson directs over $300 billion in institutional assets, making it one of the world's largest money managers. Brinson is also co-author with Yale finance professor Roger Ibbotson of a book about asset classes, investment theory and international investing.

The Swiss banks were interested in Brinson Partners for its money management business but perhaps even more for its ability to bring North American investment techniques to Europe and elsewhere in its network. Features that are taken for granted in the United States like performance measurement, incentive compen sation, quantitative tools and hedging are less familiar in Europe (see Performance Measurement, Quantitative Investing and Risk Management). At first, the relationships were rather loose with interns coming to the Chicago headquarters for training and management coordination with the Swiss management largely by encrypted videoconferencing. More recently, the risk management and tighter controls at headquarters have dictated closer ties.

Brinson has promoted the professionalism of investment management by taking an active part in its industry association, the Association of Investment Management & Research (AIMR) and its Research Foundation. He is an advocate of small, steady incremental gains in improvement of standards. Similarly, he is an advocate for small changes in asset allocation. Consistent with the Swiss style of investing, major swings are generally unlikely to take place.

Brinson argues strongly that investment decisions should focus first and foremost on markets or asset classes since that explains roughly 90% of returns. The key is to consider overall portfolio risk rather than the risk of individual assets: a sound asset allocation combines diverse asset classes in ways that increase returns without an equal increase in risk or reduce risk without sacrificing returns.

His global asset allocation strategy rests on four basic principles:

• Think global.
• The value of asset classes should not rise and fall together.
• Focus on the long term.
• Monitor and adjust allocations to accommodate changed investment climates.

Brinson believes that in a relatively short time, it will seem as odd to most investors to discuss a Europe fund's country allocations as it does now to discuss a US fund's relative exposure to each of the fifty states. In his mind, country concerns will be minimal in comparison with company concerns.

What is Global Investing?

Don't put all your eggs in one basket, the principle of portfolio diversification, is widely accepted by investors. It is normally thought of in terms of the number of assets, industries or companies across which an investor is spread: a well-diversified portfolio contains equities (as well as bonds, cash, etc.) in industries whose returns do not move together. And the lower the correlation between the returns on the various equities or other assets, the less wildly the value of the whole portfolio should swing.
Less frequently is diversification considered in relation to owning equities and other assets from different countries. But with many national markets often highly uncorrelated, this form of diversification would seem to offer the strongest potential for reducing risk, while at the same time promising enhanced returns. Particularly for investors in one of the highly valued markets of the developed world, buying foreign equities uncorrelated with their domestic market should, in principle, make their overall equity portfolios less risky and more valuable.

So global investing is in the first instance about asset allocation between equities, bonds, cash and other instruments; and second, about investing in global markets. Asset allocators benefit by diversifying across asset classes; international investors benefit by diversifying their portfolio across assets in a range of different countries. The key factor for the latter is the degree of integration of the real economies of the countries concerned. It is important to understand co-movements among different markets: the more markets move together, the fewer the benefits of international diversification.

Global data for 1998 reveals significant performance differentials between regions. The MSCI World Index rose 19.7% but only two regions Europe at 26.5% and North America at 27.1% ex ceeded that. Across the emerging markets, performance ranged from a spectacular 137.5% gain in South Korea to an 83.2% decline for Russia (see Emerging Markets). Though somewhat narrower, differences in the developed world are just as striking: Finland gained 119.1% while Norway declined 31.2%. This large regional performance differential underscores the importance of a global portfolio strategy. An asset allocation strategy that on average correctly anticipated these differences would have added significant value.

Global investment provides a security hedge and a currency hedge. Frequently, investors do not separate the two (see Foreign Exchange). Nearly all academic studies suggest that the question of currency hedging should be dealt with explicitly and should not be treated as incorporated automatically within the overall global allocation. And it is important to recognize that currency hedging may be costly and can increase risk. The Asian meltdown in 1998, for example, led to the double whammy of currency devaluation and stock market collapse.

Richard Olsen’s Reactions on Critics (Part 2)

Currency attacks are becoming a depressingly common feature of the global economy. But the exact timing of the onset of an attack is notoriously difficult to predict. Richard Olsen has developed a global financial early-warning system, which tries to do the same thing as a gadget that tells someone when they are getting their next heart attack.

Olsen comments:
We have been looking at the data now for many years and we have learned a lot about what really makes a market function successfully. And, most importantly, how the components within the market that is, the market makers, the medium and long-term investors interact, and what is required to build a healthy market or, in reverse, what leads to a negative market with large-scale shocks.
For obvious reasons, such a system would be of immense interest to regulators and speculators.
The core determining factor of a currency's value is the health of the real national economy, especially the balance-of-payments. current account. If there is a surplus in the current account, that is, a country sells more goods than it buys, then buyers have to acquire that currency to purchase goods. This adds to foreign reserves and bids up the price of that currency. Conversely, a current account deficit implies the need to sell the local currency in order to acquire foreign goods. Persistent current account deficits, particularly if allied with relatively low foreign reserves, indicate a problem.

A currency's value is also affected by levels of inflation and the domestic rate of interest. High rates of interest and low inflation make a currency attractive for those holding assets denominated in it. So typically one country raising interest rates while others remain the same will raise the value of its currency as money flows into the country. This will have a limited effect if the fundamentals are wrong.

Comparative inflation rates, interest rates and balances of payments will all give clues to likely medium-term movements of a currency. But a key factor determining short-term currency values is market sentiment. There can be a self-fueling process in which enthusiasm for a currency, or the lack of it, drives the exchange rate. Speculators might decide, as they did during the European Monetary System debacle of 19923 and the Asian and Russian crises of 19978, that a currency is overvalued or simply that there are speculative gains to be made by selling it.

Currency attacks are triggered when a small shock to the fundamentals of the economy is combined with systemic weaknesses in the corporate and banking sectors. One facet of such systemic weaknesses is the effect of belated hedging activity by some economic actors in the economy whose currency is under attack. The more these actors try to hedge, the greater is the incentive for others to follow suit. This unleashes a whiplash effect, which turns a potentially orderly depreciation into a collapse of the currency. In other words, if speculators believe a currency will come under attack, their actions will precipitate the crisis; while if they believe the currency is not in danger, their inaction will spare it from attack attacks are self-fulfilling. The magnitude of the shock necessary to trigger an attack need not be large, which makes predictions very difficult. Nevertheless, it is possible to draw some broad conclusions on the vulnerability of currencies to attack. In particular, there must be a pre-existing weakness, which will prevent the authorities from conducting a fullfledged defense of the currency by raising interest rates. The weakness may not be lethal in itself (though it can become lethal once the situation deteriorates) so it is a necessary condition but not a sufficient condition for a speculative attack.

Self-fulfilling attacks may affect any country with a fixed exchange rate and high capital mobility that is in the gray area between fully safe and sure to be attacked. Recent research suggests that countries with strong trade links with a country that has recently experienced a currency crisis is highly likely to face an attack itself the growing phenomenon of contagion in foreign exchange markets.