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Keep Shopping Overseas

With the stock market wobbling, many investors are paying more attention to fixed-income investments and reducing international equity exposure.

But it's an excellent time to add international holdings -- provided you understand the risks and content of what you're buying.

Human resources and consulting firm Hewitt Associates reports that 401(k) investors poured about $3.2 billion into international and emerging market equity funds between January 2003 and April 2006. At the end of April, the typical 401(k) account had about 7.93% of its assets in international equity.

However, 401(k) investors began reducing their international exposure in May as the stock market swooned. At the end of June, the typical 401(k) account had only 6.77% invested in international funds and another 0.74% invested in emerging markets -- a decline in total equity exposure to 7.51%, according to Hewitt. During June alone, more than a quarter of a billion dollars of 401(k) money moved out of international and emerging market equity funds -- and most of the net transfers were fixed-income bound.

Investors are right to be cautious about emerging market funds, which have been producing red-hot returns that aren't sustainable. But investors looking for a "safe harbor" and exiting from international funds of all kinds are cutting themselves off from good investment opportunities. And the exodus out of these funds is creating a buying opportunity.

Emerging Concerns

First, let's take a look at two emerging market index funds. As of mid-July, the (VEIEX) fund is up 6% year to date and 29% over the past 12 months, according to Morningstar. The iShares MSCI Emerging Market Index (EEM) exchange-traded fund is up 4.5% for the year to date and 25% for the past 12 months.

These funds have diversified exposure in emerging markets, typically with somewhat higher concentrations in South Korea (18% to 20%), Taiwan (11.2% to 16.6%), South Africa (11.5% to 13.2%), Brazil (8% to 11%) and Hong Kong (8% to 10%).

Emerging markets investments have been on a tear for the past three years -- Vanguard's emerging markets index, for example, produced a three-year annualized return of over 32% -- and that kind of performance simply is not sustainable. And, indeed, many emerging market, China and Latin American-focused funds have begun to correct.

But current pricing is inflated. Emerging market investments should be long-term holdings in every portfolio, but wait until the speculative froth blows off. If you go in now, you'll be "buying high" and setting yourself up for a downdraft.

Foreign Flair

There are, moreover, other international indices with no, or only limited, emerging market exposure.

International Appeal
Symbol Fund or ETF P/E Dividend Yield Performance (as of July 13)
YTD 12-months
EFV iShares MSCI EAFE Value Index n/a n/a 9.32% n/a
EFA iShares MSCI EAFE Index n/a n/a 8.28% 22.33%
VDMIX Vanguard Developed Markets Index 15.1 2.7 8.62% 22.71%
FSIIX Fidelity Spartan International Index 15 3 8.59% 22.77%
VGTSX Vanguard Total International Stock Index 14.4 2.8 8.20% 23.48%
SWINX Schwab International Stock Index 14.6 2.9 8.88% 21.53%
Source: Morningstar

Compared to emerging market indices, these particular index and exchange-traded funds have slightly varying amounts of exposure in the stocks of Japan (22% to 25%), the U.K. (20% to 24%), France (8% to 10%), Switzerland (6% to 7.5%) and Germany (6% to 7.6%). Only two -- Vanguard's (VGTSX) (which I hold) and Schwab's (SWINX) -- have small amounts of emerging market content. All of the others are focused on developed markets, albeit with rather small allocations to Singapore and Hong Kong.
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