U.S. Investors Flock to Risky Foreign Funds : Finance: Despite recent losses in Mexico, more dollars chase profits around the globe and leave smaller markets reeling.
The risk of foreign investing was never so evident as early this year, when Mexico’s financial crisis erupted. Suddenly, Americans who had put money into mutual funds tied to developing nations took a drubbing.
Yet even as the Mexican debacle was unfolding, several managers from the Templeton Worldwide mutual fund group were half a world away scouring another risky market where investors might be persuaded to send their money: Russia.
“We were setting up our Moscow office when everything was tanking,” recalled Sam Forester, managing director of Templeton Worldwide, a unit of Franklin Resources of San Mateo, Calif.
Their effort produced the new Templeton Russia Fund, the first such fund available to U.S. investors, and it promptly took in $78 million. That’s a pittance by mutual fund standards, but under the circumstances, how did they attract any money at all?
The same way other foreign funds did. Despite the Mexico fiasco, despite a bad year overall for foreign funds, despite the fact that the Standard & Poor’s 500 composite index of U.S. stocks has outperformed international funds in six of the last seven years, the foreign funds have attracted higher and higher sums annually--even amid this year’s woeful overseas tales.
Investors’ single-minded willingness to plow cash into the likes of Russia’s embryonic capitalist system offers a striking illustration of the mainstream appeal that has come to characterize investment in distant lands.
Global markets have gone from being an investment backwater into one of Americans’ mutual fund staples--all in less than a decade. In their relentless search for pumped-up returns, investors in the past four years alone have poured more than $180 billion into foreign mutual funds.
Thanks to Mexico--whose markets have been jarred again this month by another plunge in the Mexican peso--the phenomenon and its implications hit home this year for millions of individual U.S. investors and for many other countries with volatile and vulnerable economies.
The 5.5 million U.S. households that invest in foreign funds--whether with their savings or through retirement plans--are a major source of the cash that, under the direction of Templeton Worldwide and other fund managers, now moves with dazzling speed across international borders.
Simply by dialing their fund manager’s 800 number, investors can hop among various markets worldwide. Their fund managers, in turn, are only too happy to open more “emerging market” funds, such as the Russia fund, that slice world markets into ever-thinner pieces to attract more money by giving investors more choices.
To be sure, foreign funds are exceptionally risky, and the funds go to great pains to describe the risks in their advertising to make even the less-sophisticated investor aware of the volatility. Indeed, the Securities and Exchange Commission has never sanctioned a mutual fund group for inadequately disclosing those risks, SEC spokesman John Heine says.
Financial advisers routinely caution investors to limit their foreign holdings to 30% or less of their total investments. And if the warnings weren’t enough, all investors got a quick schooling in the risks after watching the value of their foreign funds--notably those invested in Latin America--tumble this year.
As such, these investors are both cause and victim of the “impatient capital” whose rapid movement in and out of foreign countries has collapsed markets, battered currencies and threatened governments.
Their impatient capital, in fact, is becoming worrisome for some of the emerging countries because a flood of U.S. mutual fund cash can disrupt their small economies.
In its recently issued annual report, the International Monetary Fund says its directors are concerned that mutual funds and other institutional pools of cash have “dwarfed the capitalization of developing country stock markets.” “Consequently,” the IMF says, “even fairly small changes in investor sentiment could have a significant impact [on those countries], especially if investors acted as a group.”
That’s what happened in Mexico. A gradual withdrawal of foreign funds led to the peso’s devaluation on Dec. 20, 1994, which sparked the nation’s financial crisis. But the situation was exacerbated when billions of dollars of mutual fund and other institutional dollars fled Mexican markets for safer destinations elsewhere.
Mexico illustrated how a country today can become too reliant on such “hot money” to fund its economy. In the past, a developing nation would have relied on a handful of banks for financing, which made it easier to renegotiate those debts in times of turmoil. But with hundreds--if not thousands--of money managers now providing that cash for millions of investors, such crises are much harder to fix.
Mexico’s episode, and its implications for the trade partners of developing countries, prompted a U.S.-led international bailout. And it has resulted in a proposal by leading industrial nations for a permanent $50-billion fund to stabilize the economies of developing nations.
Money managers concede that without such safety nets--even if some U.S. investors take a long-term buy-and-hold strategy with foreign funds--investors and their host countries can suffer heavy losses if other investors get impatient and flee to other markets.
Some investors do buy and hold. Fund managers said that earlier this month, those who hadn’t already fled their Latin American funds opted to stay put again, even as the peso’s latest drop sparked volatile trading in Mexican stocks.
And the willingness so far of fund managers to take the long view also has helped stabilize Mexico’s shaky economy and markets. But as investors’ sophistication has increased, so has the number willing to quickly shift that cash around the world as they ferret out chances for better returns. If enough major fund managers have a change of heart, the situation in Mexico could change dramatically.
Nor does the roller-coaster ride of international stocks seem to bother many investors who are more seasoned in foreign markets than they were a decade ago. They saw foreign prices soar in 1993, plunge in 1994 and, so far this year, badly lag the record-breaking U.S. stock market.
“It was a shocker,” Frank Devian, a Glendale investor, said of last year’s foreign nose-dive, which wiped out a 50% paper gain he’d earned on his Fidelity Latin America Fund. “But once I got over the period of mourning, let’s say, I was still positive about” investing overseas.
Why? “For diversification,” he said.
Devian is not alone. Although the sales growth of foreign funds--that is, sales minus redemptions and excluding reinvested dividends--slowed dramatically this year in response to the funds’ lagging performance, the funds’ assets are still growing.
The combined assets of “global” funds, which invest worldwide, including in the United States, and “international” funds that invest exclusively outside the United States, totaled nearly $200 billion as of Sept. 30, according to the Investment Company Institute, the fund industry’s trade group. The number of funds also keeps growing; there are nearly 500 international and global stock funds now operating.
Those numbers will probably keep rising. Fund managers looking for new pockets of gold are surveying markets not only in Russia, but also in other republics that were part of the former Soviet Union, as well as in India, Pakistan, Vietnam, Poland and South Africa.
Not all investors are preoccupied with whether they should jump from, say, a Latin America fund to a Southeast Asia fund. Jim Havlena, an accountant in Baywood Park, Calif., said his foreign investments are “for the long term, so I don’t care if it’s a rocky road in between.”
Moreover, the 5.5 million households in foreign funds represent only 26% of all U.S. fund investors, according to a survey last March by the Gallup polling organization and Scudder, Stevens & Clark Inc., a major fund manager in New York.
That means the majority of fund investors ignore foreign markets. As Phil Falier, a 56-year-old Palo Alto electronics engineer and investor sheepishly put it: “I don’t feel smart enough” to take that step.
But their numbers are shrinking. The continued surge in foreign funds’ assets and in the number of funds signals that an ever-growing number of investors want those funds--risks and all--as part of their portfolios.
They know that in certain years, foreign markets will outperform U.S. markets, and they want that hedge. “It’s money chasing returns, there’s no question about it,” said Troy Shaver, president of John Hancock Mutual Funds in Boston.
That chase for fatter profits is why the stream of American investments flowing into foreign funds became a torrent beginning in 1993.
Although the U.S. stock and bond markets were chalking up respectable returns of 10% to 12% that year, markets in Southeast Asia, Latin America, Germany, Britain and other regions were achieving returns triple those--surging toward their best showings in a decade.
Those gains weren’t lost on U.S. investors or the mutual fund industry. Fund managers, stockbrokers, financial advisers, talk-show hosts and others asserted that a portfolio had to include foreign investments if it was to be “properly” diversified.
The result: Net sales of international funds exploded to $26.3 billion in 1993 from $5.1 billion the previous year, and those investors were rewarded with an eye-popping average total return of 37% in 1993, according to Lipper Analytical Services, a fund research firm.
Seeing those profits, investors not surprisingly poured another $27 billion into international funds in 1994.
But it was also during 1994 that the international markets began plummeting. Suddenly the foreign funds’ easy double-digit returns vanished, and investors began taking a more sober look at foreign investing. Sales growth of international funds slowed to $7.4 billion in the nine months ended this past Sept. 30--a mere one-third of their growth the previous year, the Investment Company Institute said.
Some investors bailed out.
“When things went south, a lot of people went flying out [of foreign funds] and lost quite a bit of money,” Rocco said. “You could argue that the people who stayed in learned a valuable lesson.”
That’s because many of those overseas markets have staged comebacks this year--even Mexican stocks rebounded for a few months before falling again in September--enabling those who stayed put to recoup part or all of their losses.
Scudder, Stevens & Clark “expected a lot of people to turn tail and run” from its Latin American fund amid the Mexican crisis, said Scudder Stevens principal Joyce Cornell. “They didn’t.”
But it was a rough ride merely to get even again.
“The American public has gone up the learning curve very dramatically” in playing the world’s financial markets at the same time their fund assets keep growing, said John Hancock’s Shaver. “So we’re anticipating a shift to an even more global marketplace.”
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Foreign Funds Pull Back
Investors aren’t putting as much money in mutual funds that invest in foreign companies due to the funds’ meager results in 1995 compared to the U.S. market. But the number of funds and their assets are still growing.
Global funds (includes U.S.)
** Excludes single-country funds
* 1995 figure through Nov. 2
ASSETS AND NUMBERS
International Stock Funds *--*
Assets Number Year (billions) of funds 1990 $14.3 95 1991 19.1 128 1992 22.9 138 1993 71.0 196 1994 101.7 288 1995*** 116.1 342
Global Stock Funds *--*
Assets Number Year (billions) of funds 1990 $13.5 52 1991 17.3 65 1992 23.2 99 1993 43.3 107 1994 60.2 145 1995*** 74.1 160
Global Bond Funds *--*
Assets Number Year (billions) of funds 1990 $12.4 37 1991 27.2 59 1992 31.6 87 1993 38.2 115 1994 31.4 132 1995*** 33.1 134
NET NEW SALES
In billions of dollars:
International stock funds
Global stock funds
Global bond funds
Notes: Net new sales are sales minus redemptions and excluding reinvestment of dividends.
*** 1995 figures through Sept. 30
Source: Lipper Analytical Services , Investment Company Institute