I've always heard and read that we should keep a certain percentage of our portfolio in international stocks or mutual funds. Long ago, this probably made sense. But in these days of the global economy, broad-based international funds -- those not devoted to specific countries or regions -- seem to track pretty closely with U.S. funds.
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The old adage explaining this is "When the U.S. sneezes, the whole world catches a cold." Given this lack of diversification, higher expenses and possible currency risks, is it truly necessary to own international stocks or stock funds anymore?
International investing has turned out to be a major disappointment, right up there with electric cars, the Red Sox and Bill Clinton.
Putting some of your money in international stocks was supposed to reduce your risk and boost your returns, because foreign markets shouldn't move in lockstep with the U.S. But that concept just hasn't panned out over the last several years.
The average foreign stock fund has produced an annualized return of 3.2% over the past five years, trailing every U.S. stock fund category. That's even worse than the average tech fund. The average international fund has beaten the S&P 500 in only two of the last 10 years.
The strong U.S. dollar and the uncertainty surrounding the launch of the euro are two of the reasons foreign stocks have produced such pathetic returns lately. Plus, "The U.S. was the fastest-growing economy, and a lot of foreign direct investment was coming into the U.S.," says David Herro, manager of the top-performing
Oakmark International and
International Small Cap funds.
David Bowers, global strategist at Merrill Lynch, says, "There has been no other place to be other than the U.S."
But this trend can't last forever. Indeed, the dollar is near a 16-year trade-weighted high and looks overvalued. When the dollar starts to weaken, the returns on those foreign funds should start to look better. "I think the currency will turn in two, three or four years," says Herro.
That's just one of the reasons that you should keep a little bit of money in an international fund. Here are four more:
1. Foreign stocks look cheap.
If your style is more Sam's Club than Saks, then you'll understand the attraction of foreign stocks right now.
They're cheap. Valuations on companies outside the U.S. are currently much lower. Merrill Lynch's April survey of global institutional money managers found that the majority of those professionals think the U.S. is the most expensive market in the world, while they think the emerging markets are the cheapest. "The valuation case against the U.S. is pretty compelling," says Merrill's Bowers.
Oakmark's Herro cites one example: The consumer products industry in the U.S. is trading at 20 times cash flow. The same industry overseas is selling at about 12 to 14 times cash flow.
When you compare two similar companies, the difference in valuation is even more striking.
International Flavors & Fragrances
, a New York City-based company that produces (you guessed it) flavors and fragrances used in consumer goods. This company is nearly identical to
, which is run out of Switzerland. Same business. Same profitability. IFF is selling at over 15 times cash flow, while the foreign Givaudan is trading under 10 times cash flow, says Herro. "To some degree, U.S. companies tend to be well managed and should be equal to or at a premium to foreign companies," he adds. "But these kinds of premiums just aren't right."
2. The U.S. market hasn't always been the place to be.
There was once a time when international investing actually made people money. "Looking at 10-year periods beginning in 1969 (1970-80, for example) non-U.S. stocks outperformed U.S. stocks in dollar terms over every such period, other than those ending between 1995 and 2000 (e.g., 1986-96)," according to a research report from Morgan Stanley. And given the stateside accounting scandals that are spooking investors and the chance that the dollar will weaken, Europe and other foreign markets could beat the U.S. in years to come.
Ironically, one of the reasons that the U.S. has traded at a premium to international markets is better corporate governance. But that gap is closing, and it's not just Enron's fault. For example, Herro says, "Managements of European companies today are being far more responsive to owners' issues and capital allocation because they're being pushed by pensions in Europe."
3. If you've been able to tolerate a tech fund, you can probably stomach the emerging markets.
The last few years have been an excruciating lesson in how much risk comes with investing in tech. But if you have been able to endure that pain, you probably have the countenance to invest overseas -- maybe even in the emerging markets.
Opponents of foreign investing always point to the political and economic instability that comes with putting money in international markets. "The U.S. has a stable political system and a stable currency and that hasn't kept you from losing money in tech in the past year," says Merrill's Bowers.
Unfortunately, finding a good emerging-markets fund is hard. The
Dreyfus Emerging Markets fund is one of a few that has a solid long-term
record. But if you want to limit your bet on the emerging markets, you can buy a broad international fund that's run by a manager who at least looks in those developing regions for stocks to buy. If that's what you want, look at the
Harbor International II fund.
4. The world is a big place.
Almost half of the world's market capitalization is outside of the U.S. "There has to be one or two goods stocks out there," says Merrill's Bowers. And several talented stock pickers invest both here and abroad. The managers at Tweedy Browne run the
American Value and
Global funds. And Harbor and Artisan are both firms that have talented international managers.
To be sure, betting on a foreign fund is not a sure thing. Skittish investors are still clinging to the security of the U.S. stock market. And people need to reach a high level of panic about the U.S. before they run for overseas markets.
But keeping, say, 10% of your portfolio in an international fund will enable you to take advantage of any possible recovery in foreign stocks, and won't set you up for a disastrous fall.
In keeping with TSC's editorial policy, Dagen McDowell doesn't own or short individual stocks, nor does she invest in hedge funds or other private investment partnerships. Dagen welcomes your questions and comments, and invites you to send them to