International Stock Mutual FundsOverview of International Stock Mutual FundsInternational stock mutual funds are the best way for individual investors to invest in the equities of foreign companies. The alternatives, buying American Depository Receipts (ADRs) or investing directly in foreign stocks, are not especially good alternatives. There aren't enough ADRs to select from to provide a well-diversified international component in your portfolio, and direct foreign investment is way too risky and just plain impractical for an individual investor.Investing in the equities of foreign companies is much different than investing in domestic companies and is best left to the experts. Once you go beyond the ADRS that are listed on the U.S. stock exchanges, everything is much different. Foreign companies generally are not nearly as transparent as domestic firms. Although this is changing for the better, most countries have a long way to go before they'll be up to our standards, which is an aspect of international investing that we'll have to live with for the time being. The next issue you would have to deal with as a part of international investing is currency risk. The people that manage international stock mutual funds understand and know how to deal with the risks of fluctuating currencies, which is something that needs to be monitored on a daily basis. Some international stock mutual funds accept fluctuating currencies as part of their strategy while others hedge the risk. This is a very important aspect of international stock mutual funds that you need to understand and make the decision as to whether or not you want the currency risk exposure as part of your international investing strategy. Foreign securities are denominated in the currencies of the countries in which they are domiciled. Distributions, both dividends and capital gains, are made in the foreign currencies, thus international stock mutual funds owning foreign currencies must exchange the distributions for U.S. dollars before they can be passed on to shareholders. If the expected cash flow from distributions is hedged by the funds, investors will be sheltered from the risk of currency fluctuations. However, it is often desirable to accept the exposure to currency fluctuations, as this will provide another level of diversification. In this case, that additional level of diversification is manifested in the movement of foreign currencies relative to the dollar. If one of your objectives of international investing is to gain additional diversification through participation in foreign markets and thus exposure to other countries' economies, your diversification will be more complete if you select mutual funds that do not hedge the currency risk. Just remember that risk is measured in terms of volatility, so in times of volatility in the international currency markets, your funds' returns also will be more volatile. If you're a long-term investor and reinvest your distributions, this risk will be diminished. By using international stock mutual funds as one of your international investing vehicles, you will have teams of very knowledgeable professionals acquiring the information needed for comprehensive securities analysis, analyzing international economic trends and assessing their effects on the foreign securities the funds hold and monitoring the currencies of the countries in which they have made investments. With approximately half of the world stock market capitalization (as of 2007) being comprised of the stocks of foreign companies, investing internationally essentially doubles your investing opportunities. Also, various researchers have concluded that diversifying your portfolio internationally, weighted by market capitalization, has the potential to cut the expected volatility, i.e., the residual or systematic risk, of your portfolio in half. This is extremely significant and represents an opportunity that you can't afford to pass up. Ironically, many people shy away from international investing because they feel it's too risky. Diversified International Stock Mutual FundsInternational stock mutual funds invest in the stock of companies in countries outside the United States. However, there is a distinction between those that invest in the developed markets of the world and those that invest in the emerging markets. Mutual funds classified as International usually invest mainly in countries with mature economies and well-developed financial markets as opposed to countries whose economies and financial markets are in the emergent stage. The Emerging Markets funds are covered in the next subsection.From an investor's perspective, diversified international stock mutual funds are very much like diversified domestic mutual funds with the distinguishing factor being exposure to other economies. You will find the same market capitalization categories (small, mid, large and micro), investing styles (value, growth, blend and aggressive growth) and fund objectives (capital appreciation, growth and income, etc.). The diversified international stock mutual funds all tend to have their own profiles. Each one invests in different proportions in the developed countries that they prefer due to their independent analyses of different countries' economies and their own areas of expertise. Therefore, The MSCI EAFE (Europe, Asia, Far East) index that is usually used as their benchmark has limited value as a benchmark in the short term, and comparing the funds' short-term performance is difficult, as you usually aren't comparing apples to apples. If one fund does better than another in any particular year, it may simply be due to the two funds being invested in different countries. So, when comparing the performance of international stcok mutual funds, be sure to look at their long-term average performance. Regional International Mutual FundsSome international stock mutual funds specialize in specific regions, such as Europe or Pacific Basin. These funds may be less diverse geographically, but they still tend to be well-diversified across industries.The regional mutual funds can be used to over-weight your portfolio in regions for which you have a preference, for what ever reason, or you can add a collection of your favorite regions to your portfolio and still get much of the benefits of diversification that you would get from holding one well-diversified international funds. But be careful with this strategy, as many regions are subject to very high volatility. Country-Specific International Stock Mutual FundsCountry-specific international stock mutual funds are the least geographically diverse of all, as they invest solely in the companies of a single country. As you would expect, these are the most volatile of the international mutual funds.As with the regional funds, these funds tend to be well-diversified across industries. The country-specific funds should be used judiciously to over-wieght certain countries or as a speculative investment with your "mad money" outside your regular investing portfolio. International Real Estate Mutual FundsInternational real estate mutual funds offer the same benefits of domestic real estate funds. They are a wonderful opportunity to add diversification, and offer both income and the potential for capital gains. As with the domestic real estate sector, companies involved in the real estate business tend to be privately held and thus the sector is not well-represented in the general market and over-weighting of this sector is not much of an issue.International real estate mutual funds invest in the same variety of assets as domestic real estate mutual funds: equity REITs, mortgage REITs, companies directly involved in the real estate business and companies in real estate-related businesses. Don't pass up this opportunity to add an excellent diversifier to your portfolio. International Natural Resources Mutual FundsOver the years, the United States has harvested most of the low hanging natural resources fruit. Although we are by no means resource-poor, we have only a pittance compared to what we once had. The supplies of some of our natural resources are becoming exhausted and others are becoming ever more expensive to extract. Thus we are becoming more dependent on the rest of the world for many of our raw materials and fuels.Another consideration is that much of the formerly undeveloped world is now rapidly developing and also demanding those same resources, and many of those countries don't have domestic sources of those resources, so they, too, must import them. This all adds up to a lot of competition for a limited supply of natural resources. Rising demand for dwindling supplies translates to higher prices. So you have three good reasons to add an international natural resources fund to your portfolio: 1.) The supply and demand dynamic implies that NAVs should rise at a greater rate than the general market. 2.) Rising raw materials prices will result in higher prices of finished goods, energy and fuel. Owning a piece of the natural resources market provides you with a hedge against rising prices. 3.) This is yet another opportunity to diversify your portfolio. The only downside of adding an international natural resources fund to your portfolio is that, like domestic natural resources funds, they are currently (Nov. 2007) heavily weighted toward the energy sector, thus they have the potential to over-weight the Energy component of your portfolio even more. World Stock Mutual FundsWorld stock mutual funds, a.k.a. Global mutual funds, are merely international funds that have substantial U.S. holdings. As such, the only types I can think of that would have much to offer your portfolio are the world real estate and world natural resources funds, if you can find any goods ones.Currently, many U.S. real estate mutual funds have substantial holdings in other parts of the developed world, but not to the extent that they can be classified as World funds. Holding both domestic and international real estate funds in your portfolio will accomplish the same thing as owning a world real estate fund. But make sure you know the extent of the foreign holdings of your domestic fund before you purchase an international fund so that you don't inadvertently end up over-weighted in foreign real estate. You'll also find that many domestic natural resources funds have substantial foreign investments, either directly or by owning the stock of U.S. companies that have substantial foreign holdings and/or operations. I can't make any strong statement in favor of world mutual funds. If you find any world or global mutual funds that you like, be sure to take a careful look for any areas of overlap or underlap when constructing your portfolio. Your best option would be to by international stock mutual funds to complement your investments in domestic stock mutual funds. Return to the top of International Stock Mutual Funds. Return to the Various Types of Mutual Funds. Move on to the next subsection, Emerging Markets Stock Funds.
|
