International equities are playing ever more important roles in well-diversified portfolios. But managers selecting international stocks have in the past relied on much the same investment analysis they perform on domestic securities. And there are limitations to that type of analysis when they are evaluating companies in multiple countries.

Specifically, country information is generally not considered in investment decisions. Every country is governed by different laws, and companies tend to follow the laws of a country. That has a strong influence on their governance and operations (including their listing requirements, corporate structure requirements, accounting requirements, disclosure requirements, etc.). So using the typical analysis to compare a company from one country with that of another may be like comparing apples to oranges.

Thus, when looking at international equity investments, an investor must know for a given country:

• Do the financial statements accurately reflect a company’s position?

• Are shareholders protected and are there adequate controls?

• Can company leadership make decisions confidently … and without interference from a corrupt government?

The financial statements of companies in China, for instance, are not always reliable or accurate, so using that information to create forecasts of future financial performance is not always useful. When a company in Turkey has financial difficulties, investors are concerned about whether government officials or courts will respect their rights. When you’re considering an investment in Russia, the nature of the relationship between the company CEO and President Vladimir Putin tends to be more important than the financial statements.

In each of these examples, country-specific considerations have a material impact on the value of companies, something traditional investment analysis doesn’t take into consideration.

Understanding country governance requires more than financial data. Governance should measure a country’s ability to create an economic, legal and regulatory environment where output can grow, investment opportunities are attractive and investor rights protected. The required information is not easy to find or incorporate into investment decisions. What is required is a systematic and repeatable technique for collecting and processing country data, while organizing it into a format suitable for guiding investment decisions.

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