International Equity Investing -- Mid-Year 2002 Re

July 2, 2002 — As the U.S. markets complete a disastrous first half of the year, overseas markets have not fared much better, with a handful of exceptions. The markets of the Far East are strong, while the rest of the globe remains weak. South Korea, in particular, has been a bastion of growth as exemplified by two Korean-themed portfolios, the Matthews Korea Fund (MAKOX) and Fidelity Advisor Korea (FAKAX), appearing among the very best performing international equity funds. The Korean Stock Index (KOSPI) gained about 7.10% in the first half of 2002; by contrast the S&P 500 dropped 13.3% and the NASDAQ Composite plunged 20.7%.

The Korean market has benefitted from a resurgent domestic economy, robust performance from the financial services and telecommunications sectors and a strong export market (particularly with respect to the nation’s semiconductor industry). However, according to Mark Headley, the manager of the Matthews Korea Fund, the weakening U.S. dollar and the poor global economy may slow down the growth of Korea’s export economy. This is compounded by the growing strength of the won, Korea’s local currency.

The three other funds with the strongest returns all invest in Russian stocks, and their performance to date is as much a reflection of the volatile Russian markets as any underlying economic improvement. The funds are also quite small and carry high betas.

Continuing a trend from the past year, international equity funds with an aggressive growth orientation and heavy investments in technology and telecom stocks have performed the worst. At the very bottom is the Israeli-themed AMIDEX 35 Mutual Fund (AMDEX), which fell more than 40% in the first half of 2002. This portfolio has suffered the double jeopardy of exposure to both the beleaguered NASDAQ and the political crises in the West Bank.

“Telecom services and information technology stocks have performed the very worst, year to date,” said Lauretta Reeves, portfolio manager of the Hansberger International Value Fund (HINTX). “These were the most expensive sectors last year. Generally speaking when the overall markets go down, the more expensive sectors tend to get hit the hardest.”

She added that “the telecom industry is an over-leveraged sector and many companies are downgrading their numbers, particularly following the accounting scandal at WorldCom. Telecom firms had been overspending for the past couple of years to build up their infrastructure, thereby taking on a lot of debt,” she said. “Subsequently, as demand for services hasn’t come through as expected, these companies have to incur write-downs for their assets; plus, they’re still paying a relatively high interest burden as they seek to finance their debt. And this is happening around the world.”

A key factor in how international markets perform for the remainder of the year will be the ongoing decline of the U.S. dollar. As the Euro and Yen continue to rise against the greenback, foreign investors will likely continue to yank assets out of the U.S. markets, and U.S. investors may seek increasingly to place their money overseas.

As far as U.S. mutual fund investors are concerned, there already appears to be evidence that this is exactly what is happening. According to Financial Research Corp., a Boston-based mutual funs research firm, international equity funds took in net cash flow of about $6.18-billion year-to-date through May 31. Such portfolios lost about $3.68-billion in calendar 2001.

This FRC data is partially skewed by the prodigious loss of cash from the gigantic Janus Worldwide Fund (JAWWX), an $18.6-billion international growth portfolio. This fund has already seen $1.5-billion in cash exit year-to-date through May 31, after losing $2.1-billion in cash in calendar 2001. By contrast, the Artisan International Fund (ARTIX), has been enriched by $1.54-billion in new cash through May 31, 2002, after receiving $920-million last year.

Among Global Equity funds — that is, portfolios that include both U.S. and foreign stocks — the top performer, with a 17.00% gain is Comstock Capital Value Fund (DRCVX). Managed by Charles Minter, this portfolio currently has a large number of short positions.

Global equity portfolios with a heavy emphasis on aggressive growth and technology fared the poorest.

Below is a list of the five best- and worst-performing funds for each of the aforementioned categories. (Index funds and sector-oriented funds are not included.)

INTERNATIONAL EQUITY FUNDS

Best PerformersMid-Year 2002 Returns (%)Worst PerformersMid-Year 2002 Returns (%)