Overseas Earnings

The case for international funds is strong, especially given the U.S. market's current woes

In 2002, it seemed as though investors couldn’t find a safe spot on Earth to invest their money. By Dec. 11, the Standard & Poor’s 500 index was down more than 20% for the year. The developed world’s index, Morgan Stanley Capital International Inc. (MSCI), however, was off a similar amount, posting a 19.9% loss over the same period.

Don’t let that sour you on spreading some of your portfolio into overseas mutual funds. The fact remains that foreign stock funds help cushion your investments at times when the U.S. market is having trouble. To prove our point, we turned to Morningstar Inc., the Chicago mutual fund tracking firm, to check a few statistics. One number of particular interest was the average R-squared figure for funds investing exclusively in foreign stocks. By crunching statistics over time, Morningstar uses R-squared to determine how closely mutual funds keep in step with stock market indexes such as the S&P 500. A fund or group of funds that scores an R-squared of 100 relative to the S&P 500 is essentially mimicking the index, stride for stride. Conversely, a fund with a zero R-squared relative to the S&P 500 is never in step with the index.

Morningstar reports that foreign stock funds–portfolios that invest outside the U.S.–compile an R-squared of 51 on average. In practical terms, that tells investors that foreign funds will mirror the results of the S&P 500–perhaps 50% of the time–but will provide a rather good foil to shield their money during times when the U.S. index slumps.

Armed with that knowledge, we returned to Morningstar to screen for funds that have done well over the past three years. We chose that time period because we thought our readers would get a good idea of how well our choices performed at a time when the U.S. and many international markets were tossed about. We looked for funds with total returns greater than the -12% logged by the S&P 500 over the 36-month period that ended on Oct. 31, 2002. What we uncovered were some interesting possibilities.

The top fund on our list is the BlackRock International Small-Cap Investors fund (BREAX). The BlackRock fund specializes in undervalued small companies all over the globe, and while it is a relatively new offering–launched in 1998–it has a strong track record, including a 13.86% average annual total return over the five-year period ended Oct. 31, 2002. The fund’s biggest stake has been in Europe and the United Kingdom, where a little more than 50% of its assets are invested. That’s not to say that the BlackRock portfolio has shied away from the rest of the globe, though. Morningstar stats show that 15% of its money is at work in the Japan Exchange, while another 24% is invested in other parts of Asia.

Another interesting pick from our chart is the First Eagle SoGen Overseas fund (SGOVX). It, too, invests in underappreciated small companies. First Eagle has fared rather well over time. Even amidst last year’s worldwide stock market volatility, the

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