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August 04, 2003 at 08:00 PM
July 29, 2003 — The improving global economy, fading concerns about the SARS epidemic and the end of the war in Iraq proved to be a recipe for booming stock prices not just in the United States but in overseas markets as well. And U.S. investors who ventured abroad got an extra bonus in the second quarter: as the dollar fell against the euro and other currencies, their returns from those offshore holdings surged in dollar terms.
To market strategists and those investment advisors who urge their clients to keep anywhere from 10% to 40% of their stock portfolio invested in markets outside the United States, those second-quarter gains drive home an important investing lesson.
“You need to maintain allocations to international stocks at all times,” says Steve Peterson, vice president of Sand Hill Advisors, a Palo Alto-based investment advisory firm, who urges his well-heeled client base to keep at least a third of their equity holdings in foreign stock funds. “That’s the only way to be positioned when these rallies happen.”
Indeed, many investors missed out on all or part of the second-quarter gains. As the correlation between U.S. and overseas markets grew — and returns fell — beginning in the late 1990s, investors bolted. In 2001 and 2002, according to data from the Investment Company Institute, international funds saw total outflows of nearly $23 billion, and investors have been slow to return.
“The argument of old was that international investing provides diversification, and that certainly isn’t as strong an argument today,” says Roger Fenningdorf of Rocaton Investment Advisors LLC, a Norwalk, Conn. consulting firm. “But overseas investing opens up a much broader set of opportunities to investors, including some of the best companies in the world.”
Still, helping clients pick the right funds to maintain an ongoing exposure to foreign markets is a complex process. The one rule, for most advisers, is to use funds, and not try to pick stocks.
“This is one area where investment advisers are limited in their expertise, and need to know their limitations,” Peterson says.
Step one: Picking a Core Fund
Selecting a broad-based fund to serve as the core of the investor’s international-investing strategy is the first task. In most cases, this fund will represent anywhere from 50% to 100% of the entire overseas allocation, so it’s the most vital decision.
But investment advisors need to consider more than just the sector of the new fund they are studying. Standard & Poor’s suggests looking past the new wrapper and examining the quality and experience of the team managing the fund, as well as its track record and investment discipline. Both objective and qualitative information on portfolio managers and the structure of the firm is important, not only because it helps investors understand the fund better, but can provide guidance on what to expect going down the road.
“We want to find a manager whose portfolio is broadly diversified,” says Harold Evensky, a financial advisor in Coral Gables, Florida. “We want someone who may make some country bets, but maintains some kind of exposure to most of the important overseas markets.”
For Evensky — and many others — indexing overseas isn’t as attractive an option as it is at home. They believe active managers are better able to take advantage of the larger number of inefficiencies they believe exist in less liquid overseas markets.
