Are Your Clients Ready To Take A World View? Advisors need to temper enthusiasm with a systematic approach

By Jim Connolly

Advisors confidently can tell clients who want to invest outside the United States that it truly is a big, open and profitable world, mutual fund experts say.

The numbers back experts assertions. Worldwide mutual fund assets totaled $14.47 trillion at the end of third quarter 2004, according to data from the Investment Company Institute, Washington. That number is 24.2% higher than the $11.65 trillion posted in fourth quarter 2001. The ICI also reports that 44% of those third quarter 2004 assets were in equity mutual funds.

However, mutual fund executives say advisors have to channel enthusiasm and keep some key points in mind before helping clients select an international mutual fund or subaccount within a variable insurance product.

A starting point, they emphasize, is to know your practice and, hence, your client.

“How specialized is the advisor or client able to be?” asks George Greig, a portfolio manager with Prudential Financials Strategic Partners International Growth Fund, Newark, N.J. A general purpose international fund can offer investors broad exposure to international markets, he says.

Mike Cantara, an associate portfolio manager with MFS, Boston, says, “The most important thing is that there are good opportunities and value in the non-U.S. market that make a compelling case for investing in them.” There are many companies outside the U.S. which have discounted valuations, he adds.

Something between 45-47% of the worlds market capitalization is outside of the United States, and that rises to 70-72% if measured by company, according to Cantara.

A well-diversified portfolio is the best way to participate in this growth potential, he says. So, typically, 15-20% of a clients total portfolio would be invested in non-U.S. investments, he says.

Nationwide Financial, Columbus, Ohio, looks for portfolio managers for its investment products with a focus on diversified international funds rather than narrower slices of the international sector such as single region or country funds, says Ed Riley, Nationwides director of investment research and analysis. The reason, he explains, is that typically, Nationwides clients do not want to invest in funds that are excessively risky.

“A very systematic approach to the international market” is needed, says Michael Perelstein, senior portfolio manager with American Century International Growth Fund, Kansas City, Mo.

It is better to have a core allocation in a broad fund with the remaining portion sprinkled among higher risk investments such as emerging market funds, he explains.

The temptation for some investors, according to Perelstein, is to “cross the risk threshold internationally and go all the way and gamble on the most risky elements.”

He cautions advisors whose clients want to weigh exclusively the international portion of their portfolio in emerging markets. “It would be the equivalent of having a U.S. stock portfolio and only investing in the NASDAQ. It would be a very difficult ride.”

However, he adds, “The nice thing about international stocks is that there is quite a large universe of countries and cultures, stocks and sectors to choose from.”

Indeed, a compilation of third quarter 2004 data from ICI and national mutual fund associations came up with 54,446 mutual funds worldwide. Of these, 14,115 were in 7 countries in the Americas; 28,375 funds in 25 countries in Europe; 11,439 funds in 8 countries in Asia and the Pacific; and, 517 funds in South Africa.

Perelstein notes some of the points advisors should be aware of when discussing international funds with clients.

For instance, he says, decisions on international fund investments over the next year should not be tied to the recent rise in foreign currencies based on their strengthening over the last 2-3 years.

The market already has priced in stronger international fund earnings resulting from the strength of foreign currencies in the near-term, he explains. But over a 5-year period, the dollar could strengthen if the Federal Reserve continues to raise rates, he adds, and that would impact international funds rates of return.

Currently, Perelstein says, emerging markets are performing extremely well, which has benefited many emerging market funds. But, if Fed rate hikes continue, the effect will be to draw away liquidity from emerging markets, as past events have shown, he says, citing the devaluation of Mexican and Asian currencies as well as the Russian crisis in 1998 that resulted in the devaluation of the ruble and default on public and private debt.

For this reason and because “easy opportunities are not now so obvious,” Perelstein says the funds he manages are reducing exposure to emerging markets and investing in international markets that are already developed.

Although large cap stocks have not performed as well in the last 4-5 years, “the Fed, by reducing liquidity, is reducing speculative juices,” according to Perelstein, who says he will be giving large cap stocks a closer look. “Thats the environment that we are in. We are at the cusp now.”

Funds invested in companies worldwide that are less dependent on economic growth such as food and beverage companies, will be more interesting, he continues.

Advisors also should look at funds that are tracking worldwide demographic patterns, such as pharmaceutical and medical device companies that meet the needs of aging populations in Japan and Europe, he says. These companies have been undervalued but have good growth potential, he notes.

“Japan is becoming more shareholder friendly,” says Cantara.

He explains that looking at international investments from a bottom-up examination of companies rather than a top-down macro-economic approach creates “a smoother ride for investors.”

Cantara says MFS will look at companies that reduce currency risk by matching production plants to where they sell product. For instance, he asks, if you are selling cars in the U.S. or Canada, do you have plants in those countries? Other checkpoints include a companys business model, the industrys growth rate, barriers to entry, source of earnings and price to cash flow to mitigate differences in accounting from the U.S.

Prudentials Greig notes the current disparity between growth and value funds in favor of value investment. Value funds are as close to growth stock valuations as they have ever been, he notes, but adds that growth stocks such as technology companies that are consumer driven may be due for a rebound.

Nationwides Riley says he does not think most international fund managers with whom he speaks view short-term interest rates or inflation as a problem. Just a year ago, there was a deflationary scare, he adds.


Reproduced from National Underwriter Edition, April 15, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.