Future Still Bright for Foreign Investments

International stock funds rallied sharply during the first half of 1993, and in doing so wiped a lot of egg off the collective faces of investment pros around the country.

For several years now, the merits of foreign diversification have been touted by stockbrokers, financial planners, investment advisers and mutual fund managers--not to mention the journalists who quote them.

Investors have been told how international holdings reduce risk and boost returns--and how mutual funds are the simplest, most efficient way to put money to work overseas.

These ideas started to sink in on a mass scale around 1989--which marked the fifth straight up year for international funds.

So what happened next? Foreign markets embarked on one of their worst three-year stretches in memory, with Japanese securities surrendering more than half their value and most European bourses losing ground. Smaller stock markets elsewhere in Asia and in Latin America posted some decent returns over this period, but not enough to offset declines in the bigger nations.

The result: an average 6% loss for international funds from 1990 through 1992--a stretch when domestic equity portfolios gained 38%.

So the 14.6% average return for international funds from Jan. 1 to June 30 of this year came as a relief to investors who had listened to the foreign sirens. It also validated the idea that cross-border diversification works, provided you give it enough time.

“The whole idea of diversification is that it should smooth out your returns over long periods,” says Ken Gregory, co-editor of the No-Load Fund Analyst newsletter in Orinda, Calif.

But a better reason for international investing, in Gregory’s view, is that the rest of the world can be expected to grow faster than the United States, a relatively mature economy. “The bottom line is that there are a lot more opportunities elsewhere,” he says.

These should be construed not only as growth opportunities but also as bottom-fishing possibilities too. With Europe currently mired in a deep recession, European equities offer some pretty compelling values compared to what’s available here.

Funds that specialize in European stocks have an average portfolio price-to-earnings ratio of 13.5, according to Morningstar Inc., the Chicago-based research firm. That compares to 19.2 for a typical U.S. growth-and-income fund.

“We feel the European markets offer exceptional values,” says Pat Slater, an investment counselor at Financial Resources Inc. in Anchorage, Alaska. At the same time, he views the U.S. stock market as “extremely expensive,” both for fundamental and technical reasons. Consequently, Slater is recommending that clients place two-thirds of their equity fund holdings in international and only one-third in domestic.

Although few other advisers are so boldly in favor of international funds, many recommend at least some weighting in this area. “Ten percent (of one’s equity holdings) would be a bare minimum,” says Gregory, who currently recommends a 50-50 split between the foreign and domestic camps.

Whatever your preference, you will find an ample selection of foreign-flavored funds from which to choose. For the most part, these can be broken down into four basic groups--listed here in increasing order of risk.

* Global. These broad-based mutual funds can buy stocks anywhere in the world, including the United States. In fact, global portfolios at last count had nearly 40% of their assets in American companies on average, according to Morningstar. The U.S. exposure makes for a smoother ride.

* International. Investors who already have domestic stock holdings might want to stick with a purely foreign product. Most international funds enjoy wide leeway to buy anywhere outside the United States. For the most part, that means Western Europe and the Orient, with perhaps a few holdings in Latin America, Canada and the Middle East.

* Regional. Anyone seeking a more concentrated punch can opt for a fund with a specific European, Asian or Latin American bent. While more volatile than broader-based international or global funds, they also tend to move less in sync with the U.S. market--which adds a nice diversification feature. Some of the Asian and Latin American funds also have lower exchange-rate risk, since several nations in these regions peg their currencies to the dollar.

* Single-country. Funds that limit themselves to just one foreign market tend to be the most volatile of the bunch. Single-country funds are usually organized as closed-end portfolios, with shares trading on either the New York or American stock exchanges.

Within these four broad areas, you will also find funds occupying additional niches. The international arena, for example, can be further segmented into growth, value, small-company and index funds.

World Champions

Foreign investing came back into style during the first half of 1993, propelled by strong stock market gains in Japan and Canada. The following international and global mutual funds are among the better players in the field. All enjoy above-average ratings from Morningstar Inc. of Chicago.

1-Year 5-Year Max. Sales Fund/Type Return Return Charge Dreyfus Strategic World/Global +4.6% +10.8% 3% New Perspective/Global +5.7 +12.3 5.75% T. Rowe Price International Stock/Intl. +5.3 +9.6 None Putnam Global Growth A/Global +7.9 +9.6 5.75% Scudder Global/Global +12.6 +13.3 None Scudder International/Intl. +10.3 +9.3 None Templeton Foreign/Intl. +3.4 +13.3 5.75% Templeton Growth/Global +8.9 +13.3 5.75% Vanguard Trustees Equity/Intl. +9.9 +7.4 None

800 Fund/Type Phone Dreyfus Strategic World/Global 645-6561 New Perspective/Global 421-0180 T. Rowe Price International Stock/Intl. 638-5660 Putnam Global Growth A/Global 225-1581 Scudder Global/Global 225-2470 Scudder International/Intl. 225-2470 Templeton Foreign/Intl. 237-0738 Templeton Growth/Global 237-0738 Vanguard Trustees Equity/Intl. 662-7447

Note: Returns are annualized performance results for periods ended May 31, 1993.