Every Portfolio Needs Foreign Stocks

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Despite impressive gains in recent years, many global markets still offer appealing opportunities.

 

Domestic stocks have done well recently, but foreign stocks have soared. During the five years ending in October 2006, the average international stock fund returned 15.61% annually, about 8 percentage points ahead of the Standard & Poor’s 500-stock index. Can foreign markets continue climbing? Probably. Many foreign economies are growing steadily. And foreign stocks have the wind at their backs because of the falling dollar. As the dollar declines, the value of foreign stocks rises for American investors, and returns of foreign funds climb. With the U.S. recording big trade deficits, many economists expect that the dollar will continue losing value against the euro and other currencies.

 

Even if the currency experts are wrong and dollar stabilizes, it still pays to own at least some overseas shares. Because foreign stocks sometimes rise when Wall Street is in the dumps, a few overseas issues can help to steady a portfolio. And as the world economy becomes globalized, more and more profitable companies are now located in overseas, even in countries such as Brazil, India, and Korea.

 

Experts disagree about what percentage of your assets should go in foreign stocks. Some cautious financial advisers recommend allocating 10% of a portfolio to companies abroad, while others suggest 30% or more. The best way to get started is to buy a world fund for at least

part of your assets. A global fund owns stocks in the U.S. and abroad, and the portfolio managers regularly adjust the allocations. When foreign stocks seem more attractive, managers shift overseas. By owning a world fund, you allow a professional manager to take on the task of deciding how much of your portfolio should be overseas at any one time.

 

Go “global”

 

Don’t confuse world funds with “foreign” funds, which rarely invest in the U.S. market. Because world funds have flexibility to invest anywhere, top managers have compiled records that few foreign-only funds can match. “If a skilled manager can go anywhere in the world, he can find bargains that other funds can’t touch,” says Randy Linde, a financial advisor in Seattle.  

To appreciate how a world fund can gain an edge, consider Oakmark Global, a value fund that has returned 21.7% annually during the past five years. When the S&P was soaring in 1999, Oakmark had 60% of its assets in the U.S. Then the fund gradually began shifting to Europe. By 2005, Oakmark had only 30% of its assets in the U.S. and was benefiting from strong overseas markets.

 

While it often finds the hottest markets, the fund hardly follows the crowd. When many U.S. investors were focused on big technology stocks in the 1990s, Oakmark filled up with small value names. “We only buy stocks at a discount, and the technology names were too expensive for us,” says Robert Taylor, an Oakmark portfolio manager.

 

Currently Oakmark is buying big European pharmaceutical companies. With investors worried that not enough new drugs are coming to market, the pharmaceutical companies have lagged for years. But the fears are quiet overdone, says Taylor. He is particularly keen on GlaxoSmithKline, the British giant. “Glaxo has very strong profit margins, and investors will eventually embrace the pharmaceutical stocks again,” he says.

 

Another strong performer is Polaris Global Value. The fund typically holds half its assets in the U.S. But fund manager Bernard Horn currently invests only 38% of assets in domestic stocks because overseas markets seem more appealing. Horn looks for companies with steady cash flows and low prices. To stay diversified, he buys about 75 stocks in 15 countries. The resulting portfolio has proven it can be resilient in downturns. “A lot of our stocks are good businesses, but nobody cares about them because they’re boring,” he says.

 

Lately, he’s been finding many attractive companies serving Japan’s domestic markets. With the country’s economy improving, Japanese consumers are shopping more, and corporate revenues are rising. Polaris recently purchased Asahi Breweries, a beer maker that sells mainly to the domestic market. Another recent buy is Japan Railway. “This company has been ignored for years,” says Horn. “But now as the economy grows, the number of passengers should increase steadily.”

 

Another standout fund

 

If your foreign portfolio is already heavy with large-cap stocks, consider Templeton Global Small Company. Portfolio manager Tucker Scott has scored big gains by buying undervalued small and midcap stocks and waiting patiently for them to fulfill their promise. Scott will hold onto stocks for five years or longer. Many companies in the portfolio are European names reporting strong earnings gains. A favorite holding is Vestas Wind Systems, a Danish maker of wind turbines. “Now that oil is so expensive, wind is very cost-competitive,” says Scott. Templeton currently has 20% of its assets in the United States.

 

Another fund that focuses on smaller stocks is Evergreen Global Opportunity. Portfolio manager Francis Claro seeks growing com-panies that are showing improving performances. In some cases the companies suffered disappointments in the past, and the stocks sank. “We like to find inflection points, where earnings or sales are beginning to improve dramatically,” he says.

Claro is keen on Ashtead Group, a British company that provides rental equipment, such as forklift trucks. The earnings suffered several years ago when the European economy turned sluggish. With construction healthy now, earnings have been climbing, and sales are growing at an annual rate of more than 20%.

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