For better returns, look abroad

A late rally helped the Standard & Poor's 500 gain 9 percent in 2004, but where could investors have done better? Just about anywhere in the world.

Most international mutual-fund categories turned in impressive returns last year, led by Latin American funds, which jumped more than 38 percent, followed by small- and mid-cap international funds, which gained almost 25 percent, and emerging-markets funds, which advanced 24 percent. Even the average fund investing in Europe, where slow economic growth in Germany and France has been a drag on performance, gained more than 21 percent in 2004.

Looking ahead to 2005, analysts expect these types of funds to continue doing well, although investors should not expect a repeat of 2004's outsize returns. Brazil, for example, has boosted Latin American funds, thanks to steadily increasing exports of commodities such as copper and iron ore to China, India, and other rapidly growing economies. But if the Chinese economy slows down, those exports could be reduced considerably, says Gareth Lyons, an international funds analysts at Morningstar Inc. in Chicago.

"With regard to Brazil, as well as other emerging market countries, the gains have been fueled by what are arguably very cyclical factors," Mr. Lyons says. "We aren't saying China and India won't grow, won't have higher than average growth going forward, but there are bound to be some bumps along the way. I would definitely caution investors about jumping into emerging markets right now, given how strong they've been."

"I don't see any reason why Latin America should implode," says Ray Mills, portfolio manager of the T. Rowe Price International Growth & Income Fund in Baltimore. "But I'd be a little cautious at this point. Historically, the markets have had some 'cyclicality,' as have the economies."

In spite of his caution, Mr. Mills believes Latin America funds can still do well, not just because of commodity exports. For example, "we're seeing a continuation of the relief rally in Brazil that started in 2003," following the 2002 election of leftist former union chief Luíz Inacio Lula da Silva as president. After his election, Mr. da Silva pleasantly surprised analysts with his prudent monetary polices and by taking steps to get inflation under control. "That was a big help," Mills says.

Other economies in the region, including Mexico, Argentina, and Chile, also seem to be "heading in the right direction" economically and politically, he adds.

Mills also sees a number of reasons European funds have performed well, in spite of below-average performance by Germany and France. For example, Norway is benefiting from rising oil exports, while Ireland has favorable demographics and low taxes, and Austria has close ties to Eastern Europe, where continued rapid growth is helping many companies in the region.

Even Germany is showing a few signs of improvement, he says. Last year, Siemens, Germany's largest electronics company, won a concession from its largest union to increase the workweek from 35 to 40 hours. Later in the year, DaimlerChrysler got a similar concession from its German workers. Changes like these can save as much as 30 percent in labor costs, Mills estimates. Now, he says, "a lot of the medium-size companies in Germany are going to start pressing the unions for similar concessions. The unions will have to give in, at least in places."

One factor that could affect international funds is the falling US dollar. While many international funds recorded large gains for US investors, returns in some of the markets where they invest were not as impressive. Measured in euros, for example, leading European markets were up less than 10 percent last year, but the gains were much larger in dollar terms. Given the growing US budget deficit and the widening trade deficit, a further decline by the dollar seems likely, say analysts who remain cautious on this point as well.

"Some people have said the dollar's going to keep declining, so it's time to invest internationally," Mills says. "Well, it may keep declining, but you may also have a snapback. I don't think it pays for most people to try to time the currency markets or the stock markets."

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