Global Funds' New Allure

Are you wearing investment blinders? Probably so, if all you can see is Wall Street, Alan Greenspan and the techs you didn't sell. With blinders off, a new world should edge into your peripheral vision--the world of international stocks. U.S. stocks whipped the internationals during the dizzy, bubble years. But now a page is being turned. Global investing is going to look good again. If you've been holding (and hating) international funds, don't give up. If you've ignored them, think about whether they're worth a buy.

At the moment, you may not feel like buying anything. This extended bear market destroyed $1.7 trillion in personal wealth in the first half of 2002, then swept back in July to wipe out another $1.6 trillion in just two stunning weeks, says David Resler, chief economist of Nomura Securities in New York. We're living through the worst equity market since the late Depression. Between 1937 and 1942, Standard & Poor's Industrials plunged 58 percent. That compares with a 48 percent drop since March 2000, the index's modern peak.

A fundamental revaluation of stocks is going on and with good reason, says Allen Sinai, chief global economist for Primark Decision Economics. Stocks are riskier in a world where the United States might invade Iraq; where we're looped into the violence in the Middle East; where any battered suitcase could carry a "dirty" nuclear bomb; where big South American countries are falling apart, and U.S. policies seem unsure.

Besides, it's still the economy, stupid. President George W. Bush is right when he proclaims America's long-term strength. But short term, this slo-mo stock-market crash will almost certainly take a bite out of personal and business spending, corporate profits and even spiraling housing prices. "A lot of families don't even realize how much poorer they've become," Sinai says.

You see the same devaluation pressure in the rest of the world. Yet $575 million flowed into international stock funds in June, AMG Data Services reports, while more than $11 billion was fleeing funds that buy stocks in the United States. What does the international money think it knows?

First, these investors believe diversification has a lot to offer. Forget the argument that global markets move in lockstep these days--"that's bogus," says Ronald Peyton, head of Callan Associates, a leading pension consulting firm. Different types of assets shine in different years.

International stocks are generally measured by Morgan Stanley's EAFE index (that's Europe, Australia and the Far East). In 1993-94, EAFE outperformed every U.S. asset class, including big stocks, small stocks, even the growth stocks. EAFE also brought home the bacon from 1985 through 1987. In this year's first half, EAFE lost an average of 1.6 percent, but the S&P 500 stock average lost eight times as much. Foreign stocks helped take the edge off the losses you suffered at home.

International funds are also getting a bounce from a currency play. The dollar is weakening after several years of super, global strength. When the dollar declines against, say, the euro, the value of your investments in European stocks goes up. Robert Fairholm, of the International Bank Credit Analyst in Montreal, thinks the dollar could slip for another two or three years. That alone could earn you a profit even if foreign stocks disappoint.

Profits in Europe should not disappoint even if America slows, says Anais Faraj, Nomura's London-based equity strategist. A weaker dollar lowers the price that Europeans pay for oil. You'll see tax cuts, active consumers and rising public spending. Europe also seems safer from terrorism than the United States, and doesn't bear the huge expense of defending against it.

Japan remains a riskier story. A cyclical business recovery seems underway, but true financial and economic reform are words whistled into the wind, Faraj says.

Much of Southeast Asia is currently doing well, thanks to middle-class spenders taking on debt, American style. But these places are just a tiny segment of the market. Your investment results will mainly depend on Europe and Japan.

Indexed international funds are the easiest buy. They typically track the EAFE index, which reflects the performance of most non-American stocks.

In theory, mutual funds run by active managers--those who pick stocks--should have a leg up on index funds. In the 1990s, they could beat EAFE just by putting less of their money into Japan, says Morningstar's foreign-fund analyst, Bridget Hughes. But even pros can't always time the market right. EAFE funds have beaten a majority of the managed funds over time, says Gus Sauter, index guru for the Vanguard mutual-fund group. A different approach is to focus on certain types of stocks. Dimensional Fund Advisors (available only through money managers) offers international index funds that track smaller companies and "value" companies whose stocks are cheap. DFA's Rex Sinquefield thinks they give you better diversification than EAFE funds do. Firms such as T. Rowe Price and Fidelity run small-company funds, too. So there's plenty of choice. You just have to get in the game.