Plotting a Course for Your Overseas Holdings
That 97-pound weakling, the U.S. dollar, has been kicking sand in the face of the yen, franc, pound and mark lately, and investors in international mutual funds have gotten a bit banged up.
Since February, the greenback has advanced about 20%, as measured against a common index of leading currencies. The dollar’s appreciation has tempered the upside movements of funds that hold foreign securities, even though most of the larger international markets have rallied nicely this year.
Does this mean that you should pull out of your international fund? No. But it does point out the need for long-term investors to exercise patience, and it underscores the fact that currency fluctuations--which boosted foreign stocks and bonds so much during the 1980s from the perspective of American investors--are a double-edged sword.
Fortunately, there are reasons to hold foreign investments even if you must fight the current of a short-term rise in the dollar. For example, while an international or global fund in itself can be fairly volatile, such an investment can actually reduce risk and lead to better gains in the long term when combined with U.S. stock and bond holdings. This is because financial markets around the globe don’t always move in step with one another, just as the dollar doesn’t move in sync with other currencies.
“Many U.S. investors have virtually 100% of their wealth in dollar-denominated assets, so any exposure they have to a foreign currency gives them diversification,” says Roger Wilson, president of Northwest Quadrant, a money management firm in Newport Beach. He holds certain foreign funds without worrying about the currency swings. “We just look upon it as a long-term diversification thing.”
Mutual funds offer a quick and easy way to get that diversification, since they have dozens of individual stock or bond holdings and are run by professional managers familiar with foreign markets.
But for investors who own an international or global fund (the difference between the two is that global funds also hold U.S. securities), the current period of dollar strength is certainly unwelcome. International funds blew away their U.S. counterparts from ’85 through ’88 (see chart) as the greenback lost value, but since then they have lagged. Some investors must be wondering whether it’s time to sell.
David Tripple, chief investment officer for Pioneer Mutual Funds in Boston and a co-manager of the company’s Europe fund, suggests that you sit tight. In the short term, there’s no way to predict how much the dollar might rise or fall, he says, adding that a good portion of the rally may already be behind us.
More important, over the past 10 or 15 years, the U.S. currency has been losing ground at a rate of 3% to 4% annually on average, he says. “Our assumption is that there’s no reason to expect that will change over the long run,” based on projections for higher economic growth and lower inflation abroad.
Besides, a stronger dollar would tend to improve the profitability of foreign exporters, and that will eventually show up in higher stock prices. “Consider a company like BMW, which makes a large amount of its money in the U.S.,” Tripple says. “If the mark fell against the dollar, that would have a negative effect when you translate BMW’s share prices, but it would have a positive effect on the company’s profit margin.”
Some international fund managers go so far as to hedge their portfolios against a sharp rise in the dollar by purchasing currency futures contracts. Hakan Castegren, who runs the Ivy International and Harbor International funds, has done this in expectation of a further advance in the dollar. “I think another 10% to 15% rise (by next February) is quite possible,” he says.
But Castegren also believes that investors with an international bent should stick with their holdings despite periods of dollar strength, given that there are so many solid foreign companies with good business prospects.
Currently, he sees a lot of potential in Latin America, considering the recent trends to tame inflation, privatize state-owned industries and allow more direct foreign investments. His favorite markets include Brazil, now struggling with an austerity plan, and Mexico, which stands to benefit from the proposed free trade pact with the United States. “I think Latin America is going to be the big investment surprise over the next couple of years.”
Castegren also considers the stock markets in Italy, France and Spain undervalued. All three bourses have price-earnings ratios in the 11 to 13 range, below their historic norms and cheap in relation to U.S. stocks, Tripple adds. Plus, all three nations have been modernizing, improving their infrastructures and otherwise making long-term investments, Castegren says.
In addition, there’s the potential for lower interest rates in these and other European countries. Recessions in America and Britain have helped push rates lower in those countries, but not so in the northern European nations, most of which haven’t slid into recession. “When that rate relief comes, it will be a fuel for those stock markets,” Tripple says.
So don’t let dollar shock shake you out of a good international or global fund. In fact, this might even be an opportune time to add to a position. How much should you hold? As much as you’re comfortable with. “I don’t think many investors can take the lack of correlation and the volatility of having 40% of their money in international funds,” Tripple says. He suggests a 10% or 15% weighting, preferably made in modest monthly increments as part of a dollar-cost averaging program.
A Swinging Pendulum
Domestic stock funds, which badly lagged their international peers from 1985 through ‘88, have been leaders since then. This trend has resulted, in part, from the firming U.S. dollar, which acts to reduce the value of foreign securities from the standpoint of American investors. Global funds hold both domestic and foreign stocks and thus tend to produce returns roughly midway between the two.
International Global U.S. growth Year stock funds stock funds stock funds 1985 +39.5 % +37.7 % +27.5 % 1986 +53.3 +31.4 +13.0 1987 +14.0 +5.6 +1.1 1988 +16.6 +13.4 +14.0 1989 +22.3 +21.7 +25.4 1990 -12.0 -10.5 -5.5 1991 (5 mos.) +9.3 +13.3 +21.5
Source: Lipper Analytical Services
