Best Bets Seen in Foreign and Smaller Stocks : Outlook: Many world markets are catching up to U.S. trend after lagging for years. But investors can expect volatility.
The smartest mutual fund bets over the next 12 months or so may be two of the current leaders, many pros say: international funds and U.S. small-company funds.
But investors should be prepared for a potential roller-coaster ride, experts warn. Both of these fund categories are notoriously volatile, and are probably overdue for some profit taking.
International stock funds outperformed their U.S. peers for a third straight quarter in the three months ended Sept. 30. And by late July, investors finally began to take notice of the trend.
The result: unprecedented purchases of international funds by U.S. investors in August, and another heavy inflow of cash into that sector in September.
Fund experts both applaud this sudden wave of interest in foreign funds and fear it.
They applaud it because Americans have been urged for years to diversify their stock holdings globally and now appear to have taken that advice to heart.
The fear stems from the view that many investors are simply chasing performance--foreign funds are hot, so people want in.
In any case, it would be hard to ignore the numbers:
* The average international fund rose 9.35% in the quarter and is up 25.1% year-to-date, according to fund tracker Lipper Analytical Services. The nine-month figure is 1 1/2 times the average U.S. stock fund’s gain.
* Among funds that target specific world regions, Latin American stock funds jumped 12.88% in the quarter and are up 21.57% for the year, on average.
* Pacific region stock funds were up 9.56% in the quarter, edging European-region funds, which gained 8.13% on average.
For U.S. investors, foreign stock markets’ gains this year have been double-barreled: After several lean years, many world markets have turned wildly bullish this year, responding in part to the global decline in interest rates.
Also, the decline in the dollar versus key foreign currencies has automatically boosted returns for U.S. investors in some foreign markets. For example, about half the 42.9% average gain in Japanese stock funds this year is due to the dollar’s slide against the yen.
While the effect of currency changes isn’t necessarily sustainable, many Wall Streeters believe world markets still have great potential to continue topping the U.S. market’s performance over the next few years.
That’s because U.S. stocks are already three years into a bull run, while many foreign markets are this year having their first decent rally since the late 1980s. There is substantial catch-up to be done, some pros contend.
For example, Ed Games, manager of the Boston-based Scudder Latin America fund, says Argentine stock prices have a long way to go to reflect the turnaround in that nation’s economy. His fund has nearly one-quarter of its assets invested there.
“I think Argentina is where Mexico was in 1988,” Games says, recalling the Mexican bull market that has blossomed as the country has privatized state businesses, brought inflation down and generally revitalized the economy.
At the T. Rowe Price New Asia fund in Baltimore, Vice President William Wendler notes that much of Southeast Asia has been benefiting handsomely from China’s emergence as a capitalist nation--if not in name, in practice.
And apart from the China influence, Wendler notes, many Asian countries now boast economies and financial markets that are far more diversified and well-developed than a mere 10 years ago.
In Singapore, for example, the government’s mandatory payroll savings plan for workers began allowing a certain percentage of funds to be invested in stocks this year, Wendler notes. That provides a source of small-investor support for Singapore stocks.
Meanwhile, in Europe, a deep recession still has France, Germany and much of the Continent in its grip. But stocks have jumped as interest rates have begun to come down.
Although optimism about foreign stock investing is rooted in fundamentals, fund experts advise investors that the risks remain significant as well: Any decline in U.S. stock prices could be magnified many times in foreign markets, if based on sudden worries about a global economic slowdown or a global interest rate rise.
“Every other market in the world is less liquid than ours,” cautions Michael Lipper at Lipper Analytical.
But Soraya Betterton, manager of the GT Global Latin America fund in San Francisco, notes that the positive long-term fundamentals supporting many foreign companies don’t depend on what happens within the U.S. economy, or even in neighboring countries’ economies.
She cites the disparity in performance among Latin American markets this year--and among individual stocks in those countries--as an example. In foreign investing, “we’re long past the days when whole markets went up together,” Betterton says.
Small-Stock Boom: Among broad U.S. stock fund categories, funds that target small company stocks posted some of the best gains in the third quarter.
Twentieth Century Giftrust fund, for example, scored a 19.1% rise in the quarter, helped by the sharp gain in many small-company issues this summer.
Glenn Fogle, one of Giftrust’s managers, notes that small stocks are in their third year of outperforming big-name stocks. There’s a good reason why that should continue, he says: The sluggish economy favors companies that can react quickly to market opportunities, and those whose fortunes depend more on regional economies than on the national economy.
“This is an environment that allows small companies to do very well for themselves,” Fogle says.
Don Phillips, publisher of the Morningstar Mutual Funds newsletter, agrees that small stocks’ outlook remains strong. But he also notes that by definition, investing in small-stock funds and international funds requires that investors be willing to accept higher risk for the chance of higher returns.
U.S. vs. International Stock Funds
U.S. stock funds are enjoying their third straight year of gains. But international funds have begun to come on strong this year, and many investors now are flocking to those funds. General U.S. fund: 1993: +10.0% U.S. small company: 1993: +13.7% U.S. growth: 1993: +8.0% International: 1993: +25.1% European region: 1993: +16.8% Pacific region: 1993: +32.7% Source: Lipper Analytical Services
