Catch the International Flight

First, the good news. The stock market crash of 2008 lasted through March 9, 2009, but things improved rapidly after that. From March through July of last year, Standard & Poor’s 500 stock index gained 35.62%, enjoying its best five-month run since 1938. For the entire year, the average U.S. stock fund returned about 33%, and virtually every category of mutual fund tracked by Morningstar wound up with positive results.

Now, the not-so-good news: Even the strong rebound of 2009 couldn’t make up for 2008’s crisis-fueled losses–and the rest of the decade’s abysmal performance. The 2000s, in fact, were the worst decade in almost 200 years of recorded stock market history. The S&P 500 lost an inflation-adjusted average of 3.3% each year between the end of 1999 and November 2009. For the entire decade, the average U.S. stock fund returned about 1.8% a year. You would’ve done better (and spared yourself a lot of heartburn) by simply rolling over bank CDs for 10 years.

For investors who applied the old textbook lessons of diversification (that is, managing risk by filling your portfolio with a variety of investment vehicles and holdings from different industries and global regions), the strategy paid off. Over the last 10 years, international stock funds have done much better than domestic funds, returning more than 3% per year. And, by comparison, diversified emerging markets funds were excellent performers, delivering annualized returns greater than 9% during the 2000s:

Let’s put that performance in perspective. If you had invested $10,000 in the average U.S. stock fund at the end of 1999 and kept your money there, your stake would have been worth about $13,250 by year-end 2009. By comparison, the same amount placed in the average diversified emerging markets fund would have grown to roughly $22,250. What’s contributing to this outsized growth? While industrialized nations struggled to escape the recession in 2009, emerging markets such as Brazil enjoyed economic growth of more than 4%; China’s economy grew by more than 9%.

Many in the U.S. are beginning to catch on to the international investment flight. In 2009, Americans invested a record $64 billion in foreign mutual funds, and more than half of that flowed into emerging markets equity funds; the rest went into foreign bond funds. Shaba Lightfoot was among those investors who looked beyond U.S. borders for investment opportunities last year. Lightfoot, a 27-year-old student affairs coordinator at the Association of American Veterinary Medical Colleges, a nonprofit in Washington, D.C., started investing in emerging markets when her employer switched retirement plan providers to AUL OneAmerica last winter.

After conferring with an AUL investment counselor, Lightfoot decided it was time to diversify her holdings. She placed about $5,000 in the American Funds Euro Pacific Growth Fund (A EPGX). The fund has nearly 29% of its assets in Asian, Latin American, and other emerging economies, with holdings in small firms as well as large corporations. The aim of the fund is to provide long-term growth. In 2009, the fund grew roughly 39%. “I had all my eggs in one basket,” she says. “I could have suffered a major loss if the performance was poor, but now I’m diversifying and developing a solid retirement plan.

Growth Prospects

Market experts are equally optimistic about emerging markets. “It’s not reasonable to expect another year like 2009,” says Bill Rocco, a senior analyst at Morningstar. “However, emerging markets funds are likely to reward long-term investors.” Simply put, developing economies are expected to grow more rapidly than the economies of the U.S., Western Europe, and Japan. There are literally billions of people in the emerging markets whose standard of living is improving. That mass movement toward the middle class is likely to lead to hefty profits–and higher stock prices–for the companies in those countries. The world’s largest emerging economies are Brazil, Russia, India, and China. Others include Argentina, Mexico, Poland, South Africa, South Korea, and Turkey. What all these countries have in common aside from transformational economies are large populations and abundant resources.

Lee Baker, president of Apex Financial Services in Tucker, Georgia, agrees that growth in the U.S. is likely to lag. “We’re industrialized and our economy is mature,” he says. “We’re not going to see huge investments in infrastructure, relative to our population.” Emerging markets, by contrast, are in the beginning stages of industrialization. “They’re building bridges and roads and airports. Those projects create good-paying jobs, so the emerging markets are starting to have the kind of middle class that we’ve had for years. Billions of people will be buying more goods and services.”

Modern technology makes a huge difference, notes Ivory Johnson, director of financial planning at Scarborough Capital Management Inc., an investment advisory firm in Annapolis, Maryland. “Now, people in the emerging markets have the same access to information we have in the U.S.,” he says. “That makes those countries even more competitive.”