International investing losing appeal

By DAVID MOON, Moon Capital Management
March 21, 2004

If you've ever had anyone evaluate an appropriate asset allocation for you, chances are they recommended putting a portion of your assets into foreign funds. It is common for advisors to suggest investing anywhere from five to twenty percent of your assets into international equity investments. Given that the average international fund increased 34 percent last year (compared to a 28.7 percent increase for the S&P 500,) this suggested diversification seems to make sense.

Seeming to make sense is not the same thing as making sense.

Investing in international equity funds increases the number of things that can go wrong, provides diminished diversification benefit and is mostly a bet against the US dollar.

Years ago, researchers noted that the returns of non-US stock markets showed little correlation with stocks in the U.S. As a result, these researchers concluded that adding some international investments to a portfolio would lower the overall volatility of an otherwise purely domestic stock portfolio. If you could reduce volatility without decreasing your overall long-term return, this would be a good thing. Consultants, advisors and other assorted experts immediately latched onto this notion, impressing their institutional clients with their multinational recommendations.

This discovery became popular with individual investors about the same time instantaneous worldwide information flow increased the likelihood that most world stock markets move somewhat in tandem. In other words, the non-correlation diversification benefit began to disappear. Stocks around the world tend to move in the same direction ' especially compared to 40 years ago.

If the world's stock markets move in relative concert, a broad investment in foreign stocks, denominated in foreign currency, is little more than an expensive method of betting on a decline in the value of the US dollar.

Although the average international fund increased 34 percent in 2003, the value of the dollar declined 21 percent against the euro. If a European stock fund increased 34 percent last year, almost two-thirds of the return was simply the result of a decline in the value of the dollar. The return had little to do with emerging markets or geographic diversification. The international stock exposure provided only 13 percentage points of the return ' significantly less than the return of the S&P 500.

There are legitimate reasons to invest in foreign companies. Most of those reasons are specific to the individual companies. Yet too many people consider 'international investing' as a sort of broad panacea for risk reduction.

It's hard to argue with an advisor who has all sorts of graphs and pictures to convince you to diversify into other stock markets. It sounds sophisticated, if not downright safe, to 'reallocate some of your stock holdings to non-correlated, non domestic equity markets.'

How differently might you react if asked to 'short the US dollar?'

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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