International and Global Funds -- Third Quarter 20

Oct. 3, 2002 — As the U.S. stock market completes the worst third quarter since the crash 1987, overseas markets are reeling too. Across the globe, with a few minor exceptions, equities have suffered steep declines.

A quick look at the Morgan Stanley international indexes reveals that the overwhelming majority of foreign markets have sustained significant losses — anywhere from 10% to as much as 40%. Even some of the formerly robust Far Eastern economies, such as South Korea, have begun to falter of late.

How bad are some of foreign markets doing? Consider that just last week Germany’s stock exchange said it would shut down the ‘Neuer Markt,’ roughly its equivalent of the NASDAQ Index in the U.S. The Neuer Markt, which was loaded with potentially super-high-growth dot-coms, high-tech, and biotech stocks, has collapsed. Since reaching peak value in March 2000, it has since lost a devastating 96%.

In more established stock markets, Britain’s FTSE-100 index is down about 25% for the year. In the dreadful third quarter of 2002, it plunged 20% alone. Markets in other countries around the globe report similar losses. Coupled with the poor performance of domestic equity funds, which invest in stocks of U.S. companies, investors have had little to show from diversifying overseas.

Way Over There!

The three top-performing foreign equity funds on our table are invested in either Russia, or more broadly, Eastern Europe. Markets in these countries are small and volatile, but they are also backed by relatively strong fundamentals and good GDP growth.

Ironically, the best-performing equity fund this year, the Van Eck Troika Dialog Fund (TDFAX), up 18.6%, is not listed on our table since it is being liquidated due to its small size.

Looking at the bigger picture overseas, however, William Fries, lead portfolio manager of the Thornburg International Value Fund (TGVAX), is not surprised by the magnitude of losses in the major foreign markets.

“Academic studies have shown that there is a high correlation between the performance of the U.S. markets and developed foreign markets during highly volatile times such as these,” he says. “The global economy is increasingly interconnected, and so the influence of the U.S. markets on the rest of the world is more important than ever,” Fries adds. “The slowdown of the American economy, particularly, has a negative impact on foreign companies with a heavy emphasis on exports.”

One of the few bright spots the past couple years has been the burgeoning export-oriented economy of South Korea. However, even there, dark clouds are gathering. After rising about 7.1% through the first half of the year, Korea’s premier KOSPI Index has sputtered. In the third quarter alone it has dropped nearly 11%.

In Western Europe, Fries is taking a cautious stance. “The economic development on the continent has been disappointing,” he says. “I think we’ll see very slow growth there next year, probably only 1%-2% GDP growth at the most — unless we see some re-acceleration of the U.S. economy.”

Japan’s Woes

Fries is similarly cautious about Japan. “To generate GDP growth there, bank reform will be very important,” he noted. “So far, this hasn’t happened, although recently we’ve begun to see some encouraging sings. However, Japanese banks are not solvent enough to finance any economic expansion.”

However, two of the top-performing foreign equity funds this year invest in small-cap stocks in Japan. Fidelity Japan Smaller Companies (FJSCX) and DFA Invest Grp Japanese Small Company Port (DFJSX) managed to escape damage and prosper by focusing on small Japanese firms under the radar screen.

The Nikkei-225, Japan’s most celebrated equity index, was down a relatively modest 11% as of the end of the third quarter at around the 9,400 level. The Nikkei reached an all-time high of nearly 39,000 in late 1989.

Global Malaise

Among global equity funds — those that have the latitude to invest in both U.S. and international stocks — the situation is equally grim. The top performers in this category, it should be noted, have special quirks. For example, the portfolio with the best returns, the $108-million Comstock Capital Value/A (DRCVX) had 91% of its assets in U.S. Govt. obligations as of September 30. Managed by Charles Minter, this fund is up 48.7% through the first three quarters.

The second-best global portfolio, the Prudent Bear Safe Harbor Fund (PSAFX), is designed to benefit from a falling dollar and rising gold prices. The fund principally invests in foreign and domestic government bonds and gold stocks. Although Standard & Poor’s classifies these funds as ‘global equity’ portfolios, they each have the ability to swing away from equities into an array of asset classes.

The very worst performing foreign equity fund, the AMIDEX-35 Mutual Fund, invests in the largest Israeli companies traded on NASDAQ or in Tel Aviv. It is down 44.6%, reflecting the merciless battering tech stocks have endured this year. It’s not difficult to see why this portfolio has performed so poorly when one looks under the hood. As of November 30, two of its largest holdings were Amdocs (DOX), at 12.1% of assets, and Check Point Software (CHKP), at 15.1% of assets. These two companies have dropped 81% and 64% this year, respectively.

The second worst performer, the Payden EurOpportunity (PEAGX) illustrates the drastically changed face of foreign investing. After racking up a spectacular 64.2% gain in 1999, the fund has since progressively worsened. It dropped 8.4% in 2000, plunged another 43.4% last year, and has shed 44.0% so far in 2002.