As bad as the US stock markets were in 2001, international markets fared far worse. But if you're reassessing your portfolio at the start of the new year, there's no reason why you shouldn't consider investing in overseas funds.
Just choose carefully, and be sure you're well diversified.
"International funds are important to have," says Raymond Mignone, a financial planner in Little Neck, N.Y. "In theory, their performance should be less correlated to the US market, meaning their funds go up and down at different times than US funds."
That was true in 2001. Overall, overseas returns fell an average of 20 percent for the year, compared with a 7.4 percent loss by US diversified equity funds, according to Lipper research. The extent of the declines varied by region; European funds dropped by 20.6 percent, Latin American funds lost 3.2 percent.
That uneven performance is one reason investors should look to broad international funds. If you only invest in one region or country and its economy flags, you're stuck.
Politics are another wild card. An investor, for example, who purchased an Argentina-focused fund last year likely lost money, since riots resulted in the president stepping down and a likely default on $132 billion in public debt.
A more expansive fund might have cushioned some of those losses.
"By going with a broader approach, you let the portfolio manager make all the asset allocation decisions. They can look for opportunities - and avoid risks - that an individual investor might miss," says Vincent Willyard, portfolio manager for Duncan-Hurst International Growth Fund.
Investment style is another variable. Some international funds tout growth stocks, while others offer value issues. The size of the firms in which a fund invests can also vary. Some portfolio managers focus on those with small capitalizations, others on larger caps.
"Over time, the same thing happens internationally as here: Small caps do a little better. But the category is still a little more volatile and risky than bigger stocks," says Don Cassidy, senior analyst at Lipper.
There is also some thought that in the future the biggest growth opportunities overseas will come from the stocks of smaller companies. The reason: The increasingly global nature of the world's biggest companies makes them all vulnerable to the same market forces. As a result, the performance of large caps in Europe, for example, might more closely parallel their US counterparts than that of smaller European stocks.
A few other issues to consider:
Fees. The management and expense ratios tend to be higher than for US counterparts, generally because of the costs of researching foreign firms and the costs of trading in foreign currencies. Make sure you're not paying more than you would for other similar funds. You can research this by going to a website like www.investoreducation.org or www .morningstar.com that explains fee structure and lets you compare funds easily.
Global vs. international. Make sure the fund you're buying is international, which means it invests outside the US. A global fund includes investments in US markets.
Currency hedging. Some funds aspire to protect holdings from currency fluctuations by investing in foreign futures. The practice is relatively rare, however, and the funds a little pricier. There also is no clear consensus on whether the service is really necessary.
The outlook for world markets in 2002 is mixed. US equity markets are widely expected to improve. The introduction of a tangible euro might help make investments in the region more attractive. The forecast for Japan, however, is bleak, with most market watchers predicting it will further deteriorate.
Mr. Mignone generally recommends his clients allocate between 8 percent and 15 percent of their portfolios in international funds. But assess your own goals and risk tolerance before deciding what level of investment - if any - is appropriate.
Although past performance doesn't always predict future returns, Mr. Cassidy, the Lipper analyst, suggests comparing funds' track records with the Morgan Stanley Capital International EAFE Index, one of the more closely watched gauges of international investments. (EAFE stands for Europe, Australasia, and the Far East.)
Others counsel patience. "I'd say one to three years is the minimum time frame to invest in most international funds," says Bev Hendry, portfolio manager for Phoenix-Aberdeen's International, Worldwide Opportunities and Global Small Cap funds. "You often get a couple of good years and then some bad ones. If you just invest in bad years, you're going to lose out."