When the US stock market retreats, someforeign exchanges tend to shift to alesser degreeâ€”proof that internationaland US markets are not perfectly correlated. Theoil-importing United States has a low correlationwith oil-exporting Norway, an example of how lowcorrelations can diversify a portfolio.
STRONG FOREIGN MARKETS
There is no question that foreignmarkets can outperform the UnitedStates and vice versa. For instance,according to data from Lipper Inc, forthe year ending January 31, 2003, foreignstocks fared significantly better,declining 14.41% vs a drop of 22.86%for the average US fund.
If the dollar weakens further, foreignstocks held by US investors will becomemore valuable because the underlyingforeign currencies appreciate. This canenhance positive stock returns or mitigatelocal currency stock declines.
Simultaneously, the global economy is reawakeningas companies shed excess financial baggagein favor of efficient environments. Followingrestructuring, foreign stocks now have significantlycheaper price/earnings (P/E) ratios than their UScounterparts. Countries like Germany, France, andSouth Africa are trading at a little less than 8 timesthe expected 2003 earnings, while US stocksremain overvalued, especially in the large caparena. Better performance, a weakening dollar, andan abundance of cheap stock picks makes for astrong international investing argument.
Portfolios of US-based investors are not verydiversified globally, partially due to the perceptionthat the United States dominates the world economy.The United States represents about 30% of theworld's gross national product (GNP), yet the USstock market represents over 50% ofworld stock market value. This statisticpoints to an overvalued US equity marketrelative to its world contribution.
US investors who don't invest internationallymiss out on investments thatproduce about 70% of the world'sincome. The following are some benefitsof international portfolio components:
• Reduced portfolio risk. As a generalrule, US investors can expect todecrease portfolio risk by as much as50% by investing internationally. Forexample, a portfolio of 10 securities in 1industry is more risky than a portfolio of10 securities in 10 different industries.The risk reduction is due to diversificationcreated by industries that perform independentlyunder the same economic conditions. Thesame holds true for securities held in 1 country vs10 different countries. International mutual fundshave a beta of 0.6 (ie, the fund returns fluctuateabout 0.6% for every 1% change in the US market).
• Enhanced portfolio returns. Historicaldata suggest that there have been cycles when foreignmarkets significantly outperformed US markets.Differential stock market performance can bejustified by varying GNP growth rates, an abundanceof resources necessary for a particular productionprocess, differential real exchange rates,and changes in company productivity.
SAVVY STOCK PICKERS
Beware that not all international stocks will producesuperior returns. Exchange rates and politicaland economic risks can mitigate returns, but anexperienced global equity manager can navigatemarkets by making savvy stock picks.
Some of the best investing opportunities showup in unexpected places. Small European companiesare better values and are more dependent onlocal economies than multinationals. Value stockswith strong cash flow, little debt, and simple businessmodels are also flourishing.
Country selection is another important factor.In China, the prospect of 7% to 8% annualizedeconomic growth looks favorable for stocks, butinvestments in Japan remain on shaky ground asthe country struggles to defeat deflation. Onebright spot has been the United Kingdom, whichexperienced a surge in its real estate market.
Physicians with burgeoning practices can'tafford the time to scan economic and political climatesin search of a few stock picks. An accessiblealternative is a well-managed global or internationalmutual fund. There are hundreds of US-basedinternational and global mutual funds, butonly a handful of funds with the respected 5-starMorningstar rating, and fewer still run by investmentmanagers with track records of 10-plusyears. These are some important factors youshould consider when selecting a fund.
Bernard R. Horn, Jr ispresident and portfoliomanager of BostonbasedPolaris CapitalManagement. He welcomesquestions orcomments at 617-951-1365 or email@example.com, or visit www.polariscapital.com.