(MONEY Magazine) – Okay, we know--with a new currency crisis or regional meltdown seeming to come along every few months, it's hard to get too enthusiastic about foreign investing. The average international stock fund has gained a paltry 9.5% over the past three years, vs. 29% for the mighty S&P 500. But guess what? Foreign funds are on a roll. Japanese small-stock portfolios, for example, have rocketed an average of 25% so far this year, and emerging markets funds have soared 24%. Interested now?

Make no mistake--foreign investing is still risky. But the developed nations in Europe have held up well through the turmoil. And most international market experts now believe that the worst is over in Asia and Latin America. "Interest rates have come under control, currencies have stabilized and economic growth has resumed," says Leila Heckman, a global analyst for Salomon Smith Barney. Heckman predicts that GDP growth will average a solid 5.5% in Asia (excluding Japan) and 3.1% in Latin America next year. Just as enticing, these markets are trading at big discounts. In Asia (outside Japan), stocks are priced at an average of 17 times next year's earnings vs. 21 for the S&P, according to investment research firm IBES, while Latin American stocks carry an average P/E ratio of just 10.

Another positive sign is widespread corporate restructuring, especially in Asia. "Companies are throwing out old managers, adopting better accounting methods and welcoming foreign investment," says fund manager Paul Matthews, head of the Matthews International group. Those moves are encouraging both institutional and individual investors to move back into foreign stock markets. "We're seeing a lot of fund flows and momentum returning to Latin America and Asia," says DLJ global emerging markets analyst Jennifer Moran.

Of course, you shouldn't plunge into foreign funds simply to chase returns. The main reason to own international stocks is diversification--even though foreign funds are volatile, adding one to your portfolio, paradoxically, reduces your overall risk. That's because overseas markets often rise when the U.S. market is falling. True, the nonstop U.S. bull market has convinced some investors that overseas diversification is an outmoded concept. But no trend lasts forever. And in the long run, foreign funds are likely to reduce the risk in your portfolio.

Financial advisers generally recommend that you keep 12% to 20% or so of your equity money in a diversified foreign fund. If you believe strongly in the prospects for, say, Japan or emerging markets, you can consider allocating part of that stake to a specialized portfolio. In any case, be prepared to hang on for at least five years. Here's a quick tour of five top foreign funds, all of which are members of the MONEY 100 (see the June issue). For performance data, see the table on page 51.

If you like a go-for-growth approach, consider American Century International Growth, a fund with $2.8 billion in assets that buys companies with rapidly increasing earnings. Managers Henrik Strabo and Mark Kopinski have more than 60% of the fund in European blue chips such as Mannesmann, the German equipment manufacturer, and Swiss drugmaker Novartis. But they have been boosting their stake in Asia (including Japan), which now accounts for 11% of assets. "European growth is slowing, and we see better opportunities in Asia," says Kopinski. Among recent buys: Sony, Singapore Technologies Engineering and Hong Kong-based Tommy Hilfiger.

Richard Foulkes, who has run $7.6 billion (assets) Vanguard International Growth since 1981, seeks blue chips that can deliver steady earnings growth. But he prefers stocks with lower P/E ratios than their U.S. counterparts, giving the fund a value bent. Europe accounts for more than 70% of assets, and unlike his growth peers, Foulkes is still high on the region's prospects. "Europe is in a much more favorable stage of the economic cycle than the U.S.," he contends. "With spare manufacturing capacity and continued restructuring, there are still strong gains ahead." Foulkes has long kept the faith in Japan, which accounts for 14% of the portfolio. Among his favorites there are beaten-down electronics companies with strong sales abroad, such as Murata, a cell-phone component maker.

For added diversification, consider a foreign fund that buys small-cap stocks, such as $1.7 billion Acorn International, run by Leah Zell and a new co-manager, Margaret Forster. Like her husband, Acorn manager Ralph Wanger, Zell snaps up stocks positioned to benefit from broad trends. For example, after seeing that more electronics companies were turning over production to outside firms, Zell stashed 2.5% of assets in Venture Manufacturing, a Singaporean electronics maker, at $3.25 last June; the stock has zoomed to $10.50, and she believes it has further to go. Zell is still dubious about Asia's commitment to corporate restructuring, but she does see opportunities in the revamping of some Japanese companies, such as retailer Ryohin Keikaku.

If the Japanese economic recovery is truly at hand, few investors will be more relieved than Seung Kwak, lead manager of Scudder Kemper's $479 million Japan fund. Kwak joined the fund as an analyst in 1988, shortly before the Japanese market began a 10-year slump. Today, however, Kwak sees cause for optimism. "The Asian meltdown has forced a paradigm shift in Japanese corporate management," he says. "Companies are now focusing on improved profitability and shareholder value." He expects corporate earnings growth to jump an average of 17% in 2000. To find the most profitable plays, Kwak, who is a value investor, screens for neglected industry sectors, then does fundamental research, including management interviews, to choose 50 to 60 mostly midcap stocks. Recently, the fund's top holding was Benesse, the leading provider of correspondence courses; the stock has doubled in the past year. Kwak also likes Nikko Securities, which has shuffled management and forged a partnership with Salomon Smith Barney.

Emerging markets are still doing their roller-coaster act, climbing again lately after steep declines. In this highly volatile category, it's hard to beat $2.2 billion Templeton Developing Markets. Lead manager Mark Mobius has been scouring the world for bargains since 1987. Riding the recoveries in Asia and Brazil, the fund has surged 30.1% so far this year. But Mobius still sees plenty of bargains, especially in the telecommunications sector. "Telecom technology is really exploding," he says. "And when you combine efficient technology with privatization, you get an increase in profits." Even so, many foreign telecom stocks trade at just one or two times book value vs. five or six times book value for their U.S. counterparts. Mobius has stashed 11% of the fund's assets in the industry, including shares of Thai Telephone &Telegraph, Telmex, Telecommunications Chile and Brazil's Telebras. With any luck the returns will be worth phoning home about. --PENELOPE WANG AND KEVIN MAX