International Funds Gain Appeal as Dollar Dips

Iraq’s invasion of Kuwait did more than shatter the Mideast peace. It also undermined support for the dollar--a potentially favorable factor for investors in international mutual funds.

Granted, most foreign stock markets have tumbled along with the Dow Jones industrial index and Standard & Poor’s 500 index in recent weeks. However, the weakening U.S. currency has helped cushion the blow in many cases. From the standpoint of American investors, a declining dollar helps boost the value of holdings denominated in other currencies, while a rising greenback hurts.

In the fixed-income market, the currency benefit has been more apparent. International bond funds, unlike many of their domestic counterparts, have gained ground lately, with much of the increase attributable to exchange rate fluctuations.

The dollar lost value from 1985 through 1987--a good period for international funds. That downward trend resumed earlier this year and accelerated when the Persian Gulf crisis broke out, raising the likelihood of a U.S. recession, heightened domestic inflation or both. Within the past couple of weeks, the dollar hit a two-year low in relation to the Swiss franc, an eight-year low against the British pound and a post-World War II nadir against the German mark.

Some observers see further weakening ahead. Penny Dobkin, portfolio manager of the Fidelity Europe Fund and Fidelity Worldwide Fund, calls the current decline “precedent breaking” because it has occurred during a period of surging petroleum prices. Because oil is priced in dollars, the two normally move together, she explains.

The combination of more costly petroleum and a weaker dollar could result in a debilitating mixture of inflation and recession on the domestic front, Dobkin contends. For various reasons, she predicts that the German mark will be the world’s strongest currency during the 1990s. Her advice: Put part of your money in international income funds.

James Atkinson, a senior vice president at Huntington Advisers in Pasadena, sees gradual downward pressure on the greenback at least over the near term. He believes that the dollar has lost some of its allure as a safe haven during troubled periods, as illustrated by its slide during the Mideast crisis. “With the rise of some of the other economies of the world, the dollar isn’t as important a currency as it was 15 years ago,” he said.

Huntington Advisers offers three International Cash Portfolios, which are essentially foreign money market funds that fluctuate in price due to currency swings. The three funds have posted gains in the 9% to 15% range so far this year, helped by the dollar’s fall after Iraq invaded Kuwait. Fidelity also has three funds that are basically money market portfolios denominated in foreign currencies.

Despite the dollar’s recent weakening, many experts feel you shouldn’t focus on currency fluctuations when considering international investments. “We really don’t consider the foreign exchange risk,” says Charles Brandes, president of Brandes Investment Management in San Diego. “We feel the effects are usually short-term, and we’re not short-term investors.”

Rather, Brandes, who manages accounts for institutions and individuals with at least $100,000 to invest, buys foreign stocks because they often offer better opportunities. “We invest where the values are cheapest,” he says. Currently, Brandes considers stocks to be relatively inexpensive in the Netherlands, Hong Kong, Britain and even Chile, which he describes as the fastest-growing, most capitalistic nation of South America.

Brandes recommends that mutual fund investors consider closed-end “country funds” when they sell at discounts of 20% or more to their net asset values (the per-share worth of the stocks or bonds held). In recent weeks, several such funds have declined and their discounts have widened, offering the opportunity to hunt for bargains, Brandes says.

Douglas Dent, co-editor of Cappiello’s Closed-End Fund Digest in Santa Barbara, agrees. “During the present emotional frenzy, (the funds’) prices have dropped dramatically in relation to the net asset values.”

His choices include the First Australia Fund, which traded at a 24% discount as of Aug. 26, the Growth Fund of Spain (21% discount), the Indonesia Fund (11% discount), the Latin American Investment Fund (22% discount) and the Swiss Helvetia Fund (13% discount).

Sonja Kohn, president of Eurovaleur Inc., suggests that investors look past the current troubles and focus instead on the long-term potential of many foreign markets. Her New York-based money management firm concentrates on buying European stocks for institutional investors. Kohn hopes to capitalize on two dominant themes: the decline of communism in Eastern Europe and the economic unification of Western Europe in 1992. “The region has a fundamentally strong economy, and many companies have enormous hidden values,” she says.

Kohn believes that common stocks, not bonds or money market instruments, are the places to be for internationally oriented investors. Bonds yield higher nominal interest rates in places such as Britain, Australia, Sweden and Italy than in the United States. But after-inflation returns aren’t always so impressive. “Even where there is a small cushion in interest rates, it’s not always enough to compensate for currency-related risks,” she says.

It’s probable that at least some foreign stock markets will recover much better from the current slump than domestic equities. For three weeks following the Iraqi invasion, markets around the globe dropped indiscriminately, says Dobkin. “Yet the biggest economic problems will be in the United States,” she predicts.

Even in good years, the Dow Jones industrial index or the S&P; 500 hardly ever wind up at the top of the global equity standings. There’s nearly always at least one or more markets somewhere else doing better. That by itself is a compelling reason to diversify across borders.

OASIS OF STABILITY

The recent Mideast turmoil has hurt stock prices and the U.S. dollar. Whenever the greenback loses ground, investments denominated in other currencies tend to rise. This explains why mutual funds that hold foreign bonds and money market instruments are showing good gains this year, as the following chart illustrates.

Note that when the dollar falls sharply, as in 1987, the funds post higher total returns. A strong dollar tends to hurt performance, as in 1988 and 1989. The funds listed are among the leaders in the world-income category over the past three years.

Total Return Sales Fund 1987 1988 1989 1990* Fee Fidelity Global Bond +19.1% +3.7% +7.9% +6.3% None Freedom Global Income Plus +21.1 +14.5 +6.4 +6.9 None* Huntington Int’l. Cash Portfolio: Global Cash +22.5 +2.0 +4.2 +8.9 2.25% Mass. Financial Int’l. Trust: Bond Portfolio +24.5 +4.4 +7.4 +11.5 4.75% Merrill Lynch Retirement Global Bond, Class B +22.9 +3.8 +6.5 +8.8 None* Paine Webber Master Global Income +17.6 +12.2 +5.5 +13.3 None* Putnam Global Governmental Income +16.2 +14.9 +7.7 +4.5 4.75% Van Eck World Income +5.3 +14.3 +11.5 +12.3 4.75% U.S. DOLLAR (vs. other G-7 currencies) -17.5% +6.7% +1.5% -8.1%

Fund Telephone Fidelity Global Bond (800) 544-6666 Freedom Global Income Plus (800) 225-6258 Huntington Int’l. Cash Portfolio: Global Cash (800) 826-0188 Mass. Financial Int’l. Trust: Bond Portfolio (800) 225-2606 Merrill Lynch Retirement Global Bond, Class B (800) 637-3863 Paine Webber Master Global Income (800) 647-1568 Putnam Global Governmental Income (800) 225-1581 Van Eck World Income (800) 221-2220 U.S. DOLLAR (vs. other G-7 currencies)

*The Freedom, Merrill Lynch and Paine Webber funds charge back-end sales fees. All except Fidelity Global Bond levy annual 12b-1 fees. 1990 total return numbers, courtesy of Lipper Analytical Services, are through Aug. 26.