Beyond U.S. Shores

Investors who have gone offshore have been on-target. For the last five years through the end of 2006, international stock funds have returned 16.28% a year, according to Chicago-based fund tracker Morningstar. This performance is more than double the 7.22% annualized returns of domestic stock funds, and similar performance holds true for the three-year and one-year results.

Why have foreign stocks led the way this century? “At the start of the period, stock market values were much better outside the United States, and those low valuations attracted investors,” says Morningstar Senior Analyst Bill Rocco. “The U.S. dollar generally has been weak recently, which benefits investors in many international funds.” Last year, the dollar declined in value by 11% against the euro.

New York financial planner Lew Altfest points out that foreign stocks underperformed domestic equities in the late 1990s, so they had more upside prospects at the decade’s end. “In addition to above-average growth in Asia, foreign stocks have been helped by a continuing emphasis on profits in Europe,” he adds.

Harold Sharon, director of international equity investments and portfolio manager of Lord Abbett International Core Equity Fund A [LICAX] also cites rising profits. “Economic growth has been slower outside the United States,” he says, “but corporate earnings have been growing at a much faster pace. Therefore, foreign stocks still trade at a discount, compared with U.S. stocks.” Sharon, whose fund has averaged annual returns of more than 17% since it was launched at the end of 2003, says that offshore earnings have been increasing rapidly because of corporate restructuring (cost-cutting, mergers), similar to the process U.S. companies went through in the 1970s and ’80s. “That transition took 15 years in the U.S.,” he notes, “and it could take that long for foreign companies. We could be five years into a long run of superior performance.”

Altfest suggests holding up to one-third of the equity portion of one’s portfolio in international stock funds. Such diversification can reduce your overall risk while helping to maintain long-term returns. One strategy is to do your international investing through a fund that holds large-cap stocks, such as Nestlé and Toyota, from all over the world. “Large companies have more flexibility to take advantage of changing conditions, so they have more potential to gain from restructuring,” says Sharon.

If your portfolio is large enough to hold two or three foreign funds, pick some that complement each other. “You might buy a large-cap foreign fund that holds growth stocks and one that has large-cap value stocks,” says Rocco. “Another approach is to start with a large-cap fund specializing in the developed markets of Europe and Asia. Then add a foreign small-cap fund, a fund that focuses on emerging markets, or both.”

One such fund is American Funds EuroPacific Gr A [AEPGX], which holds a mix of large-cap growth and value stocks. This fund, in the top 10% of its category, has a 10-year annualized return of 11.23%. In that time, a $10,000 investment would have grown to around $29,000.

Rocco likes Thornburg