The Global Bet
Investors Who Look Abroad Should Use Caution

By Tomoeh Murakami Tse
Washington Post Staff Writer
Sunday, February 4, 2007

Six years ago, only about 8 cents of every new dollar flowing into U.S. stock funds was invested overseas. Silicon Valley and its microchip-studded stocks were the hot destination. Now, that number is hovering around 77 cents, as American investors look longingly at soaring returns in international markets.

Newcomers, such as retired federal worker Janet Laytham, who last fall put 1 percent of her assets into a Chinese index fund that had a 26 percent gain in three months, are adding to the rush.

"This is just mad money," said Laytham, who keeps most of her holdings in U.S. Treasury securities.

Many international stock indexes have outperformed their U.S. counterparts in the past few years. That's drawing more American investors who are seeking bigger gains and more asset diversification, and taking on more risk to get them.

"There's so many global leaders based outside of the U.S., it seems more and more . . . that limiting yourself simply to the U.S. doesn't make much sense," said Gregg Wolper, a senior fund analyst with Morningstar. Rising interest rates in Europe, the growth rate of developing countries and the fact that they are heavy on the hot commodities sector have also fueled the trend, he said.

But experts are advising caution because currency fluctuations can unexpectedly lower the value of investments and because there is far less transparency in most overseas markets. Regulations are generally less rigorous, as are accounting standards.

Investors have a total of $5.3 trillion invested in U.S. stock funds, including $950 billion in international stocks, according to AMG Data Services, a research firm that tracks fund flows. Although that only accounts for 18 percent, that total is growing rapidly as overseas gains outpace gains in U.S. markets and as globalization makes Americans more aware of foreign companies and products.

Last year, international funds had average returns of 26 percent, compared with 12 percent for domestic funds, according to Lipper, which tracks the performance of mutual funds. Funds that invest in emerging markets had gains of 32 percent. Gains have been even more dramatic in rapidly growing countries such as Brazil, Russia, India and China.

Some analysts and market observers say those strong returns can't last much longer. Steven Bleiberg, head of Legg Mason's global asset allocation team, said his staff began reducing its stake in emerging markets more than a year ago. A recent surge, he wrote in a December report, has only exacerbated what he thinks is an inflated valuation of emerging markets.

"We feel that they are a little too expensive for us," Bleiberg said in an interview, adding that he has been shifting his international emphasis to European markets.

Others, like David Ng, an assistant professor of finance at Cornell University, say individual U.S. investors are still not as diversified as they should be globally.

Ng, who recently co-wrote a study on U.S. investment in foreign equities, asserts that U.S. investors should have a portfolio similar to the composition of the global equities market -- about half foreign and half domestic. Other financial experts, like Francis Kinniry, principal of Vanguard Investment Counseling & Research, recommend 20 percent.

Proceed With Caution

As with domestic investing, there's no one-size-fits-all approach to putting money overseas. How much money you invest in foreign stocks and in which countries depends on a host of things -- your age, your appetite for risk and what's in the rest of your portfolio.

Glenn Totten, a political consultant in Alexandria, expanded his diverse international holdings after watching U.S. debt levels rise. Now, more than half of his assets are invested abroad.

"My feeling is that the dollar cannot stand up to the international currency market any longer without taking a hit," Totten said. "Moving out of the dollar is not so much an investment but an insurance policy."

But buying shares of a foreign company can be fraught with peril, as Warren Bailey learned when he tried to buy shares in in 1998 after the Asian financial crisis.

Bailey, a Cornell University professor who co-authored the home-bias study with Ng, thought he was getting a bargain when he told his broker to buy shares in some Indonesian banks. The returns so far? About negative 80 percent.

"I thought I was bottom-fishing," he said. "It's cheap for a reason. It was done and over with," he said. Another Indonesian company, Daya Guna Samudera, was delisted two years after Bailey bought its shares because it failed to file a financial report.

Some financial advisers think it is safer to invest in larger, better-known foreign companies because more is likely to be known about their financial health. But others, like Greg Fernandez, a financial planner in McLean who is Totten's adviser, say that globalization has tied the fate of many large firms together and to really diversify, U.S. investors should consider tilting their portfolios toward international funds that focus on small or undervalued companies, as well as emerging markets.

"If one domestic large stock goes down, there's a high percentage that an international large-company stock will go down in value and vice versa," he said. "And that's what you don't want when you are trying to diversify."

Bailey says he likes investing in foreign companies through a security known as an American Depository Receipt, or ADR. These securities represent shares of foreign companies and are traded on U.S. exchanges.

ADRs are bought and sold in dollars, and their dividends are paid in dollars. For their shares to trade on the New York Stock Exchange, companies must meet stricter U.S. listing requirements, including making regular filings with the Securities and Exchange Commission. That makes it easier for investors to find out about the health or governance of a particular foreign company.

"I always point my mother to ADRs," Bailey said. One of the companies he invested in using ADRs, Tsingtao Brewery of China, has done well -- roughly a 600 percent return over nearly eight years.

For most people, financial experts recommend looking for a diversified mutual fund that invests in a mix of developed and emerging markets. Some funds are country- or industry-specific.

Investors should check their international exposure before asking their broker to add overseas investments. It's not uncommon for domestic funds to hold a smattering of international stocks. Similarly, many core international funds likely have some emerging-market holdings.

Moreover, if you are already invested in a fund focused on large U.S. companies, you probably have some international exposure, experts say. That's because most multinational corporations, such as Microsoft and Wal-Mart, derive a significant chunk of their revenue from foreign markets.

Fees vary, though international funds on average charge slightly more. According to Morningstar, international fund fees ran about 1.64 percent of assets, compared with 1.44 percent on domestic funds. Emerging markets funds cost an average of 1.9 percent.

And investors should keep in mind the political and economic instability in many emerging markets. For example, in Venezuela, the Caracas stock exchange's main index shed almost a fifth of its value last month after President Hugo Chávez announced plans to nationalize the main telephone and electricity companies. And in a move reminiscent of the 1990s Asian financial crisis, investors in the Thai market lost billions of dollars in a single day in December after the government, in an attempt to take control of the rapid appreciation of its currency against the dollar, abruptly tried to impose rules taxing foreign investment.

Laytham said soaring returns made her nervous about a potential collapse as she watched her China index fund climb. "I read China financial news every day, poised to jump out at a moment's notice," she said. "Finally, I sold. I was going to Mexico and wouldn't follow the news, and I didn't want to come home to a surprise."