By James K. Glassman
Sunday, June 27, 2004; Page F01
For American investors, one of the thorniest questions is how many foreign stocks to own. All investors are unilateralists at heart, biased toward the homeland, and most economists think that's a mistake.
I plead guilty to this crime myself. I own only one foreign-stock fund, T. Rowe Price International Stock (PRITX), and it represents less than 2 percent of my total financial assets. (By the way, this is not a recommendation; it's a decent fund with low fees, and I have owned it for a long time, but there may be better.) I do own foreign stocks in other ways -- through a few closed-end funds that concentrate on individual developing markets and through mega-U.S. funds that also own foreign shares. For instance, among the top 20 holdings of Fidelity Contrafund (FCNTX), which I consider the best of the large-cap funds, are EnCana Corp. (ECA), a Canadian oil and gas company; Ryanair Holdings PLC (RYAAY), a Dublin-based European discount airline; Samsung Electronics, the Korean high-tech giant; and Rio Tinto PLC (RTP), a London-based mining company.
Why own pieces of companies based in other countries?
One reason is that "investing globally conveys a mighty benefit simply in terms of added opportunity," as a recent report by Sanford C. Bernstein & Co., a New York investment firm, put it. Today, U.S. stocks represent only about half the total value of global markets, down from two-thirds in 1970. T. Rowe Price's research department recently pointed out that none of the 10 largest companies that make steel, electronics or appliances is based in the United States. Listed on the 21 major markets outside the country are 1,005 substantial public corporations. Why ignore them?
But a more important reason to invest in foreign stocks is that, historically, markets have tended to move independently; when one is up, the other may be down, and vice versa. In technical terms, such markets are said to lack correlation. A good portfolio should balance off uncorrelated assets. That way, you get a smoother ride with roughly the same returns.
A study by Bernstein found that between 1970 and 1995, U.S. stocks significantly outperformed non-U.S. stocks in 12 calendar-year periods while non-U.S. outperformed U.S. in 12 years as well; in only two years were returns about the same.
But that study, you'll notice, ended in the mid-1990s. Immediately afterward, something seemed to change. Markets, especially in the developed world (North America, Europe and Japan), became more and more correlated. In 2000, for example, the average U.S. large-cap growth fund fell 16.3 percent while the average international fund fell 15.6 percent.
A study by Robin Brooks and Luis Catao for the International Monetary Fund looked at the performance of 5,500 stocks in 40 markets over the period 1986-2000. The researchers found that the correlation between returns in American and European stock prices rose from 0.4 in the mid-1990s to 0.8 in 2000. In other words, the movements of U.S. stocks could explain 80 percent of the movement of European stocks, compared with just 40 percent a few years earlier.
If shares of large U.S. and foreign companies move roughly in tandem, then, obviously, you won't benefit from a lack of correlation. Instead, you may as well own the best companies in the world, wherever they may be, without any special urgency to hold foreign stocks in your portfolio.
It's unclear, however, whether the late 1990s were an aberration or the vanguard of a brave new correlated world. Over the past 12 months (ended Wednesday), for instance, the Dow Jones World Index (which does not include U.S. stocks) returned 28 percent while the Standard & Poor's 500-stock index, the U.S. benchmark, returned only 16 percent. In 2002 and 2003, foreign stocks rose a total of 17 percent while U.S. stocks were practically flat (up 0.2 percent). On the other hand, so far in 2004 (again through Wednesday), the MSCI World Index has risen 1.7 percent while the S&P has risen 2.9 percent -- awfully close.
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