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All you jaded mutual-fund investors out there, think you've seen everything? Well, would a 400% increase in new cash flows to foreign mutual funds this year surprise you? Even though 2000 has been tough for international investing, mutual funds that buy into foreign companies are raking in the dough. International equity funds attracted $50 billion in new money through September, according to Strategic Insight, a mutual-fund research firm in New York. That compares to $10 billion in all of 1999 and a mere $2 billion in 1998.
We'll get to the guesses at why this phenomenon might be occurring later. But first, let's consider the many reasons why the flows abroad are so surprising.
Foremost among them: This is a year that most investors have lost money on their foreign fund investments. Strategic Insight estimates that owners of these funds have lost an average of 6% through September (these results take into account which funds have the most investors and when the assets came in). The average foreign fund is down 10% this year.
OBVIOUS FAILINGS. Maybe the volatile Dow Jones industrial average, which is down 8% so far this year, isn't such a bad place to be after all. "We're seeing a lot of market volatility and a lot of negative returns, but there has been a spike in interest in international equity funds," says Avi Nachmany, Strategic Insight's research director. The heavy flows have continued into September even as the funds' returns dropped sharply, he adds.
The increase in fund flows is surprising for more reasons than just the poor performance of the funds themselves. As Business Week's Nov. 6 cover story "Global Capitalism: Can It Be Made to Work Better?" documents, the failings of globalization are increasingly apparent to U.S. investors. The weak euro and slowing growth at U.S. multinationals selling consumer goods abroad have made headlines this year.
Plus, it's increasingly clear that open trade and foreign capital investment don't necessarily spur economic growth for developing nations. The 1990s were littered with foreign economic crises, including Mexico's currency crisis, East Asia's meltdown, and Russia's economic collapse. These are hardly distant events, even for investors with the shortest memories.
SIMILAR MALADIES. Another trend that runs counter to international investing: World markets are increasingly in sync in recent years. While the weak euro has certainly played a part, much of the slide in foreign funds this year is due to the same factors that have stalled U.S. markets: a revaluation of high-growth stocks in the telecommunications, media, and technology sectors, says Kunal Kapoor, senior fund analyst at Morningstar. Likewise, international funds owe a lot of their strong returns in previous years to those sectors. "In that sense, these funds are very similar to U.S. funds," Kapoor says.
That weakens the argument that foreign investing offers the benefits of diversification. "In the short-term, in terms of bear markets, diversification isn't helping at all," says Sheldon Jacobs, editor of the No-Load Fund Investor newsletter. As stock returns of foreign nations are increasingly correlated with the U.S. markets, "international investing is probably less important today than it was 10 years ago," says Jacobs.
So why the gush of cash this year? At least part of it may have to do with investors abandoning U.S. tech stocks. The Nasdaq composite index has fallen 19% so far this year and is 35% off its record 5047 high reached in March. Those kinds of losses have investors looking elsewhere to put their money.
CRISIS-RESISTANT. Another primary reason why money is racing to foreign funds has to do with their strong returns in 1999, when they topped average returns for U.S. funds, guesses Nachmany. International funds returned 45% in 1999, while the average domestic equity fund was up just a little over 20% last year. Despite the strong showing of U.S. markets last year, Asia's recovery from the depressed levels of its financial crisis, accounted for a big part of the spectacular returns in international funds.
Nachmany also thinks international crises of recent years have actually made investors more comfortable with foreign stocks -- simply because the punished economies have largely been able to bounce back. "The world did not fall apart," he says. "If anything, the resolution of the crises is reassuring."
Many investors are also seeing opportunity in Europe because they expect the euro to stabilize. "I think we'll see it strengthen, and we'll see more liquid and more responsive markets as a result," says Ross Levin, president of financial planning firm Accredited Investors. He has client portfolios weighted as much as 25% to 30% in international stocks and 10% in international bonds. His favorite funds include Artisan International (
ARTIX
), which is down 13% this year, but was up 81% in 1999; Acorn International (
ACINX
), down 15% this year and up 79% in 1999; and Tweedy, Browne Global Value (
TBGVX
), up 10% this year and up 25% in 1999.
DISENCHANTED. Kapoor is also high on Acorn and Artisan, as well as Scudder International Growth (
SCINX
), Templeton Foreign (
TEMFX
), EuroPacific Growth (
AEPGX
), and Harbor International (
HAINX
), which recently reopened to investors.
Even Jacobs, who is a bit disenchanted with the diversification benefits of international investing, recommends that clients put 20% of assets in foreign funds to take advantage of opportunities for stock appreciation going forward. He suggests that investors buy one European fund, such as Scudder Greater Europe (
SCGEX
) or T. Rowe Price European Stock (
PRESX
) and one general international fund, such as Longleaf Partners International (
LLINX
). For investors who want to construct a portfolio of funds they don't need worry about, he recommends using index funds, such as Vanguard's European Stock Index (
VEURX
) or Total International Stock Index (
VGTSX
).
It's clear that even if investors don't think diversifying overseas has any real benefit in itself, they do see opportunity in foreign investing right now. That's in sharp contract to a decade ago when the experts touted the benefits of investing abroad -- and most fund investors were terrified of the idea.
More investment advisers today argue that international investing isn't necessary now because so many U.S. companies do business overseas that domestic equity portfolios, in fact, represent an investment abroad. Still, fund investors see an upside to having some money invested abroad. Says Nachmany: "That's why we always focus on what people do and not what they say."
Stone is an associate editor of Business Week Online
Questions or comments? Join in the discussion at our Ask Amey Stone Forum Edited by Beth Belton
Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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