The attraction of owning a foreign stock fund lies with the two key components that investors seek.
- Great returns: For example in 1999 the average foreign stock fund gave happy investors a return of around 44% compared to the S&P; 500 which gave returns around 22%.
- Diversification: Diversifying your investment allotments into foreign funds means you increase the chances of having a good performer even if the domestic markets are in a sulk. (Morningstar)
The wise investor looks at foreign stock funds as another stream of income. There are possibilities of soaring returns but also risks of precipitous drops in the return percentages. John J. Ray, writing for Forbes.com notes that mutual funds are a good way to add what he calls “a little foreign spice” to your investment portfolio.
Foreign funds can be volatile due to any number of factors not affected by, and not controlled by U.S. investment laws. It pays to have a complete knowledge of your foreign fund manager’s strategy and style. Two key issues to investigate are:
- How often does the manager of your targeted fund invest in the emerging market sectors?
2. What region or what countries does your fund manager focus on? (Morningstar)
Foreign Funds often spike while U.S. funds are dragging so a portfolio that balances the risks can offer good return potential and diversification. Check with your fund manager and the Morningstar fund rating to examine a target fund’s past returns. Check the funds exposure to emerging markets and volatile local influences. You must understand the degree of insulation from American markets in order to accurately assess the risk in opposition to the perceived potential returns of small cap foreign companies. (Morningstar)
Understanding style is as critical in foreign fund investments as it is in domestic U.S. fund investments. Style balances value and growth, and looks at the capitalization of the stocks in which your target fund invests. I particularly like the Morningstar style box for the quick visual on investment style. The large-blend foreign fund will be the easiest way to take advantage of both the large-value and the large-growth foreign stocks.
A wise investor always keeps the performance of the stock’s parent country in mind. When you look at those foreign funds remember that your return is the combination of how well your stock is performing and the value of the country’s currency against the U.S. dollar. If you buy a stock from Company (A) which is based in the “National Republic” of (B) and the stocks value increases 15% but the Currency falls 20% against the U.S. dollar you lose. If your fund manager is working to eliminate the exposure to the volatility of foreign currencies they will be hedging their currencies by trading in the “National Republic” currencies for U.S. dollars. Buying and selling the stock is totally separate from the buying and selling of the currencies involved. The stock is traded in the equities market. The foreign currency can be contracted for sale at a set future date so the fund is in effect guaranteed a specific exchange rate. Currencies are exchanged in the global currencies market. This separation of activities means the hedging of the currencies has nothing to do with the valuing of the actual stock itself and nothing to do with the fund manager’s decision to buy or sell those companies stocks. Some funds hedge currencies and some do not. It is important to know what your fund’s policies are. (Morningstar)
Explore your options for investing in foreign funds by contacting trusted fund managers. Forbes lists international and global fund families. Here are four funds from their best buy list:
1. Oakmark International Fund-1
- Lazard International Small Cap-Open
- Vanguard International Value
- Alpine International Real Estate Equity-Y
International fund managers may be a bit more daring than domestic fund managers so it pays to re-evaluate your own risk tolerance before you look at investing in foreign funds. Try to match your risk tolerance with the risk behavior of a fund’s management style in order to avoid unsustainable risks that influence your overall investment strategy.