Looking Overseas for Retirement Income

Long-term potential growth cited--Retirement Plan Advisor, the monthly retirement newsletter for June 2006

Investing in international stocks and bonds has increasingly become par for the course among those seeking to get the best out of the markets for their retirement. Indeed, an exposure to foreign investments is key for anyone who wants to make sure they have a well diversified retirement portfolio, advisors say, and even in light of the recent decline in emerging markets assets (which have yielded superior returns over the past year), individuals--particularly those in their 30s and 40s--would be well served by having a sleeve of their portfolio invested in these instruments.

"If you accept the idea that the effective construction of long-term portfolios requires a collection of poorly correlated assets, then it is necessary to include foreign equities," says Raymond Benton, CFP at Denver, Co.-based Lincoln Financial Advisors. "Foreign bond funds also may add an additional element of diversification to a well balanced bond portfolio, and unhedged funds offer direct exposure to currency risk as well as high yield opportunities."

According to Morningstar data ending May 31, 2005, international equity funds in the U.S. by far outpaced the S&P 500 for the preceding three-year period, while 98.4% of these funds outperformed the benchmark over the prior five years.

"You could have owned the worst of the 1,145 foreign funds and had a better return than the measurement used for average U.S. stock funds," says Matthew Chope, a CFP in Southfield, Minnesota.

That said, Chope also points out that such a run cannot last forever, particularly with respect to emerging markets assets. "We are in the late innings of the performance of emerging market equities versus domestic companies, but even if this is perceived as a riskier asset class, it should still figure as a component of a retirement portfolio," he says.

Why so?

Simply put, emerging markets offer a great deal of growth potential in the long-term as globalization continues, Benton says. Most countries on the path to becoming full-fledged market economies have adopted much more effective macro-fiscal policies, including inflation targeting regimes, flexible exchange rate regimes and more prudent fiscal regimes, and this has strengthened their positions immensely and made them more attractive as investment targets for foreign investors.

But at the same time that globalization has helped increase the potential of many countries, it has also served to make the world a flatter place, and to render markets more intertwined, thereby reducing to a certain extent the potential for high returns. For this reason, advisors like Hemant Singh, founder of New York-based Private Wealth Management, are increasingly encouraging their clients to look at countries like India and Brazil, which although an important part of the global economy in terms of the goods and services that they provide, are growing organically and from within, rather than in function of demand for what they provide from the more developed nations.

"These are unique markets where it seems to me that multinationals are not the cause of the local growth," Singh says. "India is an organic economy in the sense that India itself can make and then eat what it makes without very much help from the outside. By contrast, China is totally dependent on the rest of the world consuming its products. As for Brazil, it is very rich in natural gas and coal and is becoming a net exporter of its resources."

Having access to India and Brazil is important, Singh says, as they offer investors an alpha opportunity to benefit from their growth directly without an overlap in other more established economies.

Overall, though, advisors still recommend that international assets, particularly emerging markets stocks and bonds, remain a small part of an overall portfolio, serving to enhance and complement, rather than to define. Emerging markets are the most susceptible to downturns in the global economy, Benton says, and now, with fears of inflation once again rife, these markets would be the first to suffer if interest rates were to rise and there should be an ensuing flight to quality.

Commodity prices have also been at record highs, and many emerging market nations that are commodity producers have benefited from this. Should prices fall, these same countries would suffer, and market volatility would increase.

"Because emerging markets can be very volatile, as we once again recently discovered, the exposure should generally be limited to 5% or 10% of investment assets," Benton says.

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