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The New York Times, July 10, 2005

IS IT TIME TO FOLLOW THE PACK OVERSEAS?

Investors just love foreign mutual funds these days, and no wonder.

Funds focused on overseas stocks gained 11.1% on average, for the three years through June, compared with a gain of 9.3% for domestic stock funds. And the money has kept pouring in. From the beginning of 2004 through May, foreign mutual funds had $157.1 billion in net inflows, according to the Financial Research Corporation. That is 47% of all net stock and bond inflows since the start of last year — and from a category that accounts for just 16% of total stock and bond fund assets.

All that money sloshing around has created a problem for people looking to start investing overseas or to shift their international investments. Many prominent funds have closed for new investors, including Fidelity Diversified International, Julius Baer International Equity and Tweedy, Browne Global Value. Some of those that remain open are looking rather bloated.

Assets in the largest foreign fund, American Funds’ EuroPacific Growth, have swelled to $54.5 billion, and more than two dozen others top $5 billion. While big funds that buy large-cap stocks can still do well, megafunds are typically harder to run than their smaller, more nimble brethren. A rapid inflow of money can make that task even harder.

So should investors join the rush to international funds? While chasing returns can be a road to disaster, so can the guessing game for when the market will turn. “It’s been frothy because people were attracted by the high returns,” says Mark Salzinger, publisher of the No-Load Fund Investor. “But if you try to be too tricky with the timing you lose out.”

It wasn’t long ago that investing abroad was out of favor. But as the United States economy slogged along and the euro gained against the dollar, the returns from overseas exceeded those from domestic stocks.

“The weakness of the U.S. dollar has meant that for a U.S. dollar investor, the returns from foreign investing have been very strong,” explained Jamie Doyle, co-manager of the Causeway International Value fund, a solid performer that closed to new investors this year.

Looking ahead, he said that “we do not see the plethora of massively cheap stocks that we saw two to three years ago.” That, combined with the recent strengthening of the dollar, may mean that the exceptional returns of the past few years are unlikely to continue.

In fact, this year through June, foreign funds have declined 0.68% on average, while domestic stock funds rose 0.04%.

Still, financial advisers commonly recommend a foreign stock allocation for their clients’ portfolios, typically 10% to 20% of the equity portion. Over the long term, foreign stocks have remained a worthwhile diversification component for a portfolio.

“What happened in the last three months or will happen in the next three months is not as important as what happens over the long term,” said Stuart Ritter, a financial adviser at T. Rowe Price.

Investors looking to buy an international fund may now need to look a little harder because so many funds — especially smaller-cap funds — have closed to new investors. Of course, many closed funds are still available to investors through their retirement plans or their financial advisers. But “there are still good funds out there that are open,” said William Samuel Rocco, a Morningstar analyst. “You need to look for the same thing in an international fund that you always do in a fund — good management, reasonable-to-low expenses and a proven track record.”

In addition to large funds with good records, like Harbor International, Templeton Foreign of American Funds’ EuroPacific Growth, several smaller offerings are worth a look. Among them are Oakmark International, a large-cap value fund run by David Herro and Michael Welsh, that owns just 63 stocks and posted a three-year annualized return of 12.1% through June, and Dodge & Cox International Stock, which had an annualized return of 19.8% over that period.

Others are Third Avenue International Value, an eclectic, concentrated fund that has returned 25% a year, on average, over the three years; and T. Rowe Price International Discovery, a smaller-cap fund with an annualized return of 22.3% over that time.

For those seeking a fund with fewer assets, Mr. Rocco points to ICAP International, which has an experienced management team and slightly more than $100 million in assets. It has posted a three-year annualized return of 14.4%.

If market uncertainty makes you want to avoid any stock-picking in a fund, alternatives include exchange-traded funds like iShares MSCI EAFE Index, which tracks a broad index of international stocks.

Whatever route investor choose, they shouldn’t jump in all at once, Mr. Rocco said. Instead, he advocates investing regularly overseas over the long haul, as one part of a complete portfolio. “It’s probably a mistake to rush in right now,” he said. “But it does make sense to dollar-cost-average in. People are too concerned about ‘Did I miss the party?’”

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