Foreign-fund investing: Time to tread carefully

Call it a zero-sum game: Investing overseas - for now at least - is about as productive as investing on Wall Street.

International investing is currently a washout. Oh, a few international mutual funds are doing well, as is always the case when you are dealing with several thousand funds, including all share classes. But most international funds are in the doldrums, as has been the case for US stock funds this year. Most international funds were also down last year, although they posted solid returns in 1999.

According to information firm Morningstar Inc., in Chicago, Japan funds are down 2.2 percent for the year through April 27. Europe is worse, down more than 11 percent; Latin America is down about 0.5 percent, and emerging-market funds (representing many third-world nations) are down just under 3 percent.

Measures of the US stocks, meanwhile, are mixed. The Dow Jones Industrial Average rallied into positive territory, up 0.2 percent through Friday. The Standard & Poor's 500 Index, however remains down 5.1 percent for the year.

The bottom line: If you want upbeat returns to offset the US market, don't look overseas. Nor is that scenario likely to change soon. International investing, for the remainder of this year, is expected to produce tepid to dismal returns, analysts say, reflecting the lackluster growth in the world economy.

Global economic growth, for 2001, "will be around 2 percent, at best," says Nariman Behravesh, an economist with Standard & Poor's DRI, an economic consulting firm in Lexington, Mass.

Europe, he says, will post growth of about 2 to 2-1/2 percent; Japan, he says, may be "heading toward a new recession;" Asia "is slowing because it has looked to the US for growth." And Latin America looks only so-so, Mr. Behravesh says.

Still, some market analysts, including Paul Farrell of CBS Marketwatch.com, believe that it may be time to once again plug into a solid international fund. An overseas fund provides instant diversification. But beyond that, having an overseas exposure may now be timely, optimists like Mr. Farrell argue, to take advantage of potentially rising economic activity abroad.

"Usually what goes down the most has the best chance of rising the most," notes Sheldon Jacobs, editor of the No-Load Fund Investor, a newsletter. US funds, he adds, outperformed international funds during the past five years. In that sense, international funds can be expected to at some point once again outperform US funds.

Still, Mr. Jacobs would commit no more than about 10 percent of any portfolio to international funds. Some experts go as high as 25 percent. But "stock markets are now far more correlated than they were in the past," Jacobs says, making the case for diversification less crucial. Moreover, given the strong dollar vis-a-vis many overseas currencies, including the euro, international funds face an uphill battle in terms of growth, he says.

When going international, investors should ask themselves two key questions:

1. Do you buy an international fund that has no US stock component, or do you buy a world or global fund that includes US stocks?

2. Do you buy a country or regional fund (say, Europe or Japan) or a broad-based fund, that tracks many nations?

Addressing the first question, Jacobs recommends going with a pure international fund, rather than a fund with a US presence. Presumably, he says, investors already have exposure to the US market.

So far this year, returns from the two types of funds differ little. Both international funds and global funds are down about 10.6 percent through April 24, according to Morningstar.

Jacobs would also buy a broad-based fund with stocks from many regions, rather than a regional fund. To win at regional investing, you have to know exactly when to get in and out of the market, he notes - a task that professional money managers find difficult.

He also warns investors to be cautious about expense ratios. International funds typically have an expense ratio of about 1.8 percent, compared to about 1.4 percent for a managed US stock fund. Over time, that extra percentage can drain off thousands of dollars from returns.

In addition, find out how an international fund's portfolio is structured. says Gregg Wolper, a senior analyst with Morningstar who specializes in international funds. The Comstock Value A fund, for example, has a small amount invested in Vietnamese stocks, but most of its assets are in cash.

Some international funds take a risky aggressive-growth approach, while others use a value strategy. Either way, to minimize risk, make certain the funds are largely linked to developed nations, recommends Mr. Wolper.

(c) Copyright 2001. The Christian Science Monitor