CBS MarketWatch Barbara Kollmeyer:Storming foreign shores

Storming foreign shores
Non-U.S. stocks gain favor among investment advisers
By Barbara Kollmeyer, MarketWatch
Last Update: 8:37 PM ET Feb. 16, 2005
CBS-MarketWatch

LOS ANGELES (MarketWatch) -- Conventional wisdom suggests devoting 10 percent to 15 percent of an investment portfolio to international stocks, but nowadays that advice might be short-sighted.

Recommended allocations of 20 percent, 30 percent and even 50 percent have become increasingly popular as financial advisers and investment professionals look outside of the U.S. for better stock bargains and corporate earnings growth.

"Valuations look better overseas right now. Prospects for stocks look good around the world, but foreign markets are a little cheaper on average," said Tom Hazuka, chief investment officer at Mellon Capital Management.

The firm's model portfolio favors stocks over bonds and cash, Hazuka said, with two-thirds of that stance earmarked to non-U.S. companies.

While shareholders of large U.S. multinational stocks will gain exposure from the foreign revenues those companies generate, most U.S. investors are short of even a 10 percent portfolio allocation to international markets. Yet for others, the importance of non-U.S. stocks is not lost in translation.

According to TrimTabs Investment Research, $48.2 billion flowed into international mutual funds (not including U.S. stocks) in 2004, the biggest tally since $31.2 billion poured into that sector in 1996.

Investors have pumped an estimated $4.6 billion into non-U.S. equity funds this year through Feb. 9, according to Emerging Portfolio Fund Research data. The pace reflects an "extensive asset allocation shift taking place," the report noted, with cash going to global/international, emerging markets, Europe, Japan and Pacific funds. Meanwhile, investors have pulled about $1.6 billion from U.S. equity funds, EPFR said.

U.S. dollar weakness is a key reason for the favorable interest. The dollar's 20 percent decline versus the euro in 2004 alone put wind in the sails of many non-U.S. stocks, especially those with large-scale European operations. That, in turn, tended to lift results for related mutual funds.

Faraway eyes

Ben Tobias, a certified financial planner at Tobias Financial Advisors in Plantation, Fla., invests aggressively outside of the U.S. on behalf of clients, allocating 25 percent to 35 percent of a portfolio to non-U.S. stocks.

"If you believe in true globalization, and I do... capital markets overseas over the long term will have to grow faster than the markets in the U.S. to achieve equality," Tobias said. More rapid growth, he added, should deliver higher returns over time, but he advised keeping a wide geographic moat.

"A very big risk overseas as opposed to the U.S. is the currency and political risk," he said. "It's important to be well-diversified overseas between countries and sectors and continents."

Tobias recommends four mutual funds for broad international exposure: American Funds EuroPacific (AEPGX: news, chart, profile) ; Julius Baer International Equity (BJBIX: news, chart, profile) ; DFA International Value (DFIVX: news, chart, profile) and DFA International Small Company (DFISX: news, chart, profile) .

The Julius Baer fund, for example, counts among its top holdings energy giant BP (BP: news, chart, profile) (UK:BP: news, chart, profile) and telecommunications leader Vodafone (VOD: news, chart, profile) (UK:VOD: news, chart, profile) , both U.K.-based, and OTP Bank (OTPGF: news, chart, profile) , a top financial services provider in Hungary.

Chris Orndorff, managing principal for Payden & Rygel Investment Management, advocates more targeted international exposure. He suggests that investors divide a 25 percent non-U.S. stock allocation by putting 5 percent in Europe, 10 percent in Asia and 10 percent in emerging markets.

"The fastest economic growth is in the emerging markets -- Korea, Taiwan, China, Mexico," Orndorff said.

A place for emerging markets

The emerging-market theme is a common strategy among advisers who are increasing allocations to non-U.S. stocks.

Leila Heckman, president of Heckman Global Advisors in New York, which advises mutual funds, said exposure to Asia, both developed and emerging markets, is a top recommendation.

"We continue to like emerging markets because they tend to be cheaper. Interest rates are coming down in general, and they continue to have momentum money flow in," she said.

But given the volatility of emerging markets, Heckman advises investors rely on a fund or financial adviser with experience in this specialized area.

One often overlooked advantage to investing outside of the U.S. is that increasing exposure to international stocks beyond a 15 percent allocation can actually reduce overall portfolio risk, Heckman added.

"The riskiness of a portfolio is determined by several things," she said. "One is the volatility of the assets you're investing in, and the other is the correlation of the stocks or countries you're investing in. When you put those things together...around 20 or 30 percent you actually get a reduction in risk from a 100 percent U.S. portfolio."

Brad Durham, EmergingPortfolio.com's managing director, said he favors a 50-50 divide between non-U.S. and U.S. stocks.

Emerging-markets stocks belong in a portfolio for several reasons, Durham said. He pointed to four consecutive years of superior returns and improved corporate credit quality and economic growth in these regions.

"The Julius Baer International Equity fund has a 20 to 25 percent weighting in emerging markets. It's no coincidence that it's one of the top performing international equity funds," Durham said.

John Rice, investment officer at Keats, Connelly and Associates in Phoenix, allocates about 50 percent of his clients' portfolios to international stocks. Almost half of that investment is given to large-capitalization companies, 30 percent to smaller stocks in developed markets and 25 percent to emerging markets, he said.

"If you're going to go after the exposure for overall stock markets, you should have half outside the U.S.," Rice said. After all, he noted, "Half of the world market is outside of the U.S."

Barbara Kollmeyer is a reporter for MarketWatch in Los Angeles.