Does Going Global Pay?
International funds are this year's hot thing. Here's what you need to know before heading overseas
(MONEY Magazine) – Investors are pouring beaucoup bucks into foreign-stock funds. From January through June, nearly $58 billion flowed into international offerings vs. $15 billion in the first half of 2003. It's easy to see why: The typical foreign fund is up 22% over the past year, almost double the average for domestic portfolios. Funds that play mainly in Asia are up as much as 56%.
MONEY has often said that foreign stocks are an important part of a diversified portfolio. That's still true. But it's also dangerous to chase performance. So before you dive into international waters, a few words of warning.
The streak may be cooling
Over the past 30 years, U.S. and foreign markets have posted nearly identical annualized gains of around 11%. That makes sense—both U.S. and foreign markets are driven by similar economic cycles that even out over time. And sure enough, some of the trends that fueled foreign markets last year are now looking weaker. Take the recent boom in Asian markets, spurred by the sizzling Chinese economy. Forecasters expect China's growth to slow over the coming year as government officials there try to engineer an economic "soft landing."
Another big source of overseas gains for U.S. investors was the falling dollar. If your mutual fund held stocks in foreign currencies and didn't hedge, it could've made a profit even if the stocks were duds. The MSCI EAFE index of foreign stocks is up 21% over the past 12 months in dollar terms but only 9% in local currencies. Still, the ups and downs of currencies also even out. The dollar, in fact, is up 4.5% from its 2004 low.
Foreign funds can be pricey
The average foreign-stock fund carries an expense ratio of 1.5%, compared with 1.3% for the typical domestic portfolio. Since you can't count on foreign funds to beat U.S. stocks in the long run, you should avoid paying much more than you would to invest closer to home.
They often mimic U.S. funds
As globalization brings economies closer, American and overseas stock markets are increasingly moving in the same direction. Consider a measure called correlation: If U.S. and foreign markets were in perfect sync, their correlation would be 100. Historically, large-cap foreign shares had a correlation of about 50 with U.S. large-caps—pretty low. But that number has risen to the mid-80s in recent years. Translation: You could easily lose money in U.S. and foreign stocks at the same time.
So why should you own a foreign fund? Because there's always the threat that economic events or political changes will cause U.S. stocks to dramatically underperform the rest of the globe. What's more, some foreign shares—especially small-cap stocks and those in emerging markets—still have a low correlation to the U.S., so they could help to reduce your overall risk. Three good no-load picks: Causeway International Value, a large-cap value fund (866-947-7000); Tweedy Browne Global Value, for mid-size and small value picks (800-432-4789); and T. Rowe Price Emerging Markets Stock, which focuses on developing nations (800-638-5660).