With risks mounting in U.S. markets, foreign investments look more attractive
By Jeff Brown
Stock market investors are enjoying a good run this year, but there’s still plenty to worry about. What if the economy cools, the Fed keeps pushing interest rates up or corporate earnings disappoint?
Isn’t there a way to get stock market returns while hedging against the risks overhanging the United States?
Yes: by investing in foreign stocks, which is easier through the growing array of mutual funds and exchange-traded funds specializing in offshore issues.
The comparison so far this year is dramatic: The average foreign stock fund was up 15.6 percent this year through Thursday, according to Lipper, the fund tracking company. The average U.S. stock fund was up 7.5 percent.
You can even invest through passive, index-style funds, which many investors and market pros now believe work as well with foreign stocks as with American ones.
Index funds how hold about 15 percent of the assets in foreign-stock funds compared with about 5 percent in 2001, according to AMG Data Services.
Studies show the average American investor has about 13 percent of his stock and bond portfolio in foreign stocks, while many advisers recommend 20 percent or more.
Clearly, Americans are getting the message. On Thursday, the Investment Company Institute, the mutual fund industry’s trade group, said investors had poured more than $61 billion into foreign-stock funds in the first three months of the year versus less than $32 billion for domestic stock funds.
For the last 12 months, U.S. stock funds are up about 23 percent and the foreign ones 41 percent. And for the last five years, the domestic funds have averaged a disappointing 5 percent return per year compared with 12 percent for foreign funds.
Some countries are just soaring. Latin American funds are up 94 percent over the past 12 months, and emerging market funds, which specialize in less-developed countries, are up 61 percent.
It’s risky to jump onto the latest hot investment, as you may end up buying at the peak and suffering a subsequent plunge. But over the long term, foreign stocks offer investors another way to diversify, which reduces a portfolio’s risk. That’s because stocks in foreign countries often rise when U.S. stocks are falling, and vice versa.
Also, many foreign economies have more room to grow than the U.S. economy does.
The best way to boost your foreign stock holdings is through mutual funds or exchange-traded funds, which are mutual funds that trade like stocks. Funds provide broad diversification and professional management.
In the past, financial advisers tended to recommend actively managed foreign-stock funds, thinking professional stock pickers could unearth gems better overseas than in the U.S., where analysts and business reporters cover stocks more intensively.
An indexer buys and holds the stocks in a broad market gauge, thus saving its investors the high costs managed funds incur for stock picking. In the U.S., low costs generally help indexers beat managed funds over long periods. But with foreign stocks, indexers generally trailed managed funds during most of the ’80s and ’90s.
In recent years, however, indexers have gained a slight edge, according to fund-tracking company Morningstar Inc. One reason is a 2002 change in the chief foreign-stock index, the Morgan Stanley Capital International EAFE, which stands for Europe, Australasia and Far East. Japanese stocks, which had been in a prolonged slump, now have a smaller role in the index.
With Americans pouring money into foreign stocks, managed funds are scrutinizing foreign markets harder. . Thus, there may be fewer and fewer undiscovered bargains overseas, making it harder for active managers to beat the indexers – especially as researching foreign stocks is costly.
So an investor intrigued by foreign stocks should start by looking at indexers that cover the world, such as those tracking the Morgan Stanley EAFE. That would include exchange-traded funds, such as the Barclays iShares MSCI EAFE Index Fund (ticker: EFA), as well as mutual funds such as the Vanguard Developed Markets Index (VDMIX), Fidelity Spartan International Index (FSIIX) and E-Trade International Index (ETINX).
For a longer list, go to morningstar.com and type any of those ticker symbols into the Similar Funds tool.
If none of your portfolio is in foreign stocks, don’t jump to 20 percent overnight, as there’s a risk of a pullback after the big recent gains. But that’s a good target over the next couple of years.
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