criteria; in particular, whether the investor follows a top-down or bottom-up investment strategy. Most of the equity investors in our sample tend to follow a bottom-up strategy. In this case, a team of analysts typically uses company data to calculate various accounting ratios and make projections on earnings, and to ultimately highlight those shares that look cheap or expensive. The investability issue arises either before the process is initiated, where the investment team decides whether to include company data from a particular country, or it is discussed after a short list of potentially profitable companies is created. In the latter case, the managers take a closer look at the company to see if it falls short in implementing minimum standards.

For the top-down investor, by definition the analysis of the country comes first in the process. Depending on the characteristics of the business, the decision of whether a country is on the feasible list can be prompted by a specific potential transaction, or can be taken before transactions are considered as part of the management of overall country risk exposure for the firm. For example, many emerging market investments are undertaken by investment managers who are part of a larger firm (or bank) that wants to be aware of and control aggregate, country level exposures. In this case, the firm’s risk department and/or risk committee decides whether the firm as a whole will invest in the country, and if so, the maximum amount of monetary exposure. Subsequent decision-making occurs after this “top-level” process. However, even in such an environment specific transactions may prompt changes in firm wide policies as individual managers ask for new or expanded lines to accommodate those specific transactions. For institutional topdown investors, which include dedicated emerging market investment funds, insurance companies and pension funds, the analysis of whether a country is investable is a by-product of the overall macroeconomic and political analysis of the country, which ultimately results in the identification of a number of investable countries based on the individual country scores achieved.

The last distinction which differentiates the investability criteria is between investments in hard or local currency. As we detail later, the most fundamental factors on the investability decision, especially for “may invest” countries, are related to the added complexity and insecurity of transacting and registering ownership in a local market, which is typically a necessity for all local currency investors, whether debt or equity. Hence, local currency investors will try to take this complexity into account in advance of doing any bottom-up analysis. Furthermore, the ability of investors to hedge currency exposure does have some impact on the investability decisions, for example through access to a non-deliverable forward (NDF) market or a functioning currency forwards or futures market.<sup>3</sup> Here again local currency investors will stress different factors than hard currency investors in creating the feasible set of countries for allocation.

> 3 Non-deliverable forward (NDF) contracts are instruments traded in foreign exchange markets.  In an NDF contract, two parties agree on the future level of a currency cross on a specific date.  On the agreed future date, the difference between the prevailing and contracted rate is settled in U.S. dollars; no local currency changes hands.  NDF contracts were created for Latin American currencies in connection with the 1995 "Tequila crisis" but have subsequently become widespread.  In these transactions, counterparty risk becomes a large issue, as well as the ability to establish a non-manipulatable reference exchange rate.

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