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Fund Family Shareholder Association
www.adviseronline.comfor the past five years but has generally
trended higher. This has been a head-
wind for U.S. investors, because as the
dollar rises, profits earned on stocks in
foreign currencies are translated back
into fewer dollars. By contrast, a weak
dollar gives U.S. investors a tailwind
when investing overseas. But the dollar
won’t just keep rising and foreign cur-
rencies won’t just keep falling. When
the trend reverses, we’ll have a nice
tailwind pushing returns higher.
Time in the Markets
So, let’s get back to the concern
mentioned at the outset: Is now a
good time to be invested in foreign
stock markets? You could have asked
this a year ago or five years ago. My
answer wouldn’t have changed: Yes,
absolutely.
The headlines are grim. Europe is
in rough shape. If you are looking for
a solution to the problems in the euro
zone, well, it is above my pay grade—if
there even is a solution. At this point, it
appears that the cycle of crisis, politi-
cal chicken and Band-Aid bailouts will
continue. Greece’s experience may be
the latest and may cool anti-austerity
parties in other countries given the hor-
rendous conditions that have developed
in the Greek economy. But the worries
and uncertainties aren’t over for the
euro zone.
China, as I’ve been reporting to you
in the newsletter and numerous recent
Hotlines
, has also been contributing
its share of negative headlines, and
the recent report of 7% growth in the
second quarter just seems all too per-
fect to be true. Fumbles on the policy
front, whether related to economic poli-
cies or investment and market policies
like those that spurred the tremendous
volatility in mainland markets, sow
further doubts and uncertainties about
this global giant.
Yet, you know that old saw about
markets climbing walls of worry. With
worry aplenty,
European Index
is up
7.6% this year;
Pacific Index
, on the
back of a big rebound in Japan, is up
8.1%; and
World ex-U.S. SmallCap
Index
is up 4.5%. Contrast that with
Total Stock Market Index’s 3.5% gain.
Diversification Still Alive andWell
Jack Bogle’s antipathy to investing
overseas notwithstanding, there remains
a strong diversification benefit in own-
ing foreign company stock. Yes, there
are times when correlations between
markets have been high, meaning the
diversification benefit was low, but that
isn’t always the case.
Correlation is a measure of how
synchronized two markets are. If the
U.S. market and international markets
were in complete synchronicity, they
would have a correlation of 1.00, which
implies they move 100% in lockstep.
Over the past several years, the cor-
relation between U.S. and foreign mar-
kets have moved closer to 100% as
the global economy has become more
intertwined. Yet, as you can see in
the graph below, they’ve never been
perfectly correlated, and recently have
fallen much further out of sync.
A higher correlation in and of itself
is not a reason to avoid foreign stocks.
First off, the argument could just as eas-
ily be flipped around: Given the higher
correlation between U.S. and foreign
stocks, wouldn’t I do just as well put-
ting all of my money in foreign stocks?
Maybe, but remember that just because
markets are correlated doesn’t mean
they are earning identical returns. And
falling correlations, as you can see in
the graph, could suggest that one market
is gaining while another is dropping.
Added Risks
I would be remiss if I didn’t discuss
something I mentioned above. While
investing overseas assumes the same
risks inherent in investing in our U.S.
markets, there are two additional areas
of risk that must be considered.
As I noted before, the first is cur-
rency risk. Unlike owning U.S. funds
or ETFs, when you buy a fund or ETF
investing in overseas markets, you own
stocks that are valued in their local cur-
rency, be it the Japanese yen, the euro,
or the Brazilian real. The movement
of the U.S. dollar against these curren-
cies can enhance, or detract from, your
returns in foreign markets. A falling
dollar makes shares in foreign curren-
cies worth more; a rising dollar makes
them worth less.
I don’t believe that it makes sense to
try to actively manage the currency risk
in our portfolios—the managers of the
foreign funds we use may be doing so
themselves. That said, currency market
considerations and what I know and hear
from our portfolio managers can, on the
periphery, inform my decisions about
how much money to allocate overseas.
Another risk that I haven’t men-
tioned until now is political risk, and
we’ve seen it in spades in Greece lately.
When investing in a foreign stock fund,
you are not only making a wager on
the prospects of a set of companies,
you are also making an investment in
the political and economic stability of
the countries those stocks are traded
in. Until recently, this risk was the
domain of emerging market economies.
Unsustainable levels of debt, threats of
default and currency devaluation, rising
interest rates, bank runs, failed elec-
tions—these were supposed to relate to
developing countries struggling to find
their place in a global economy, not
the long-standing, developed European
economies of Greece, Portugal or Spain,
for instance. I take some comfort in the
fact that the managers at International
Growth, for instance, are boots-on-
the-ground knowledgeable about these
risks and are investing your money, my
money, and their own in a fashion that
takes these considerations into account.
So given the rewards and the risks,
how should you and I incorporate for-
eign stocks into our portfolios?
As discussed above, I don’t agree
with the no-foreign-fund camp or the
U.S. and Foreign Stock
CorrelationsChangeOver Time
6/73
6/76
6/79
6/82
6/85
6/88
6/91
6/94
6/97
6/00
6/03
6/06
6/09
6/12
6/15
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
3-yr.
5-yr.
10-yr.