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11 places better to invest than the U.S.
One money manager says he can prove that countries with the most economic freedom are the best places to invest. You'll need to look overseas; one ranking puts the U.S. at just 12th.
By Timothy Middleton
The United States may be the land of the free, but it's not the land of the freest.
Economically speaking, that distinction belongs to Hong Kong, closely followed by Singapore, Luxembourg and Estonia. They rank highest on the Heritage Foundation's 2005 annual Index of Economic Freedom list (click here to download the document). The United States is tied with Switzerland for 12th place.
In theory, the freest economies should reward investors the most. "Wealth is created by people using their abilities to the fullest," says Marc Miles, director of the foundation's Center for International Trade & Economics.
There's some evidence it's more than just theory. An investment adviser in Charlottesville, Va., has put his clients' money where this logic leads, using exchange-traded funds to invest in 10 of the freest foreign markets.
Since 2002, says David John Marotta of Marotta Asset Management, this strategy has beaten the MSCI EAFE foreign-stock index by 5.43 percentage points annually. (MSCI EAFE stands for Morgan Stanley Capital International Europe, Australasia, Far East.)
Related news and commentary on MSN Money
The foreign-stock conundrum
American investors are chronically torn about investing overseas. Although foreign stocks have been on a tear lately, their long-term performance is not good. But Marotta's strategy improves the odds that foreign investments will succeed, in part because it excludes such weak economic sisters as Japan (No. 39) and France (No. 44).
"Those countries with the most economic freedom experience the greatest GDP growth," Marotta says, "and therefore the best returns in their stock markets."
This isn't always true. Controlled economies like Russia (No. 124) and Venezuela (No. 146) sometimes perform exceptionally well. But it is generally true. In recent years, at least seven of the 10 ETFs in which Marotta invests have beaten the EAFE.
Here's how the portfolio compares to the index:
| The freedom portfolio vs. the EAFE | | iShares fund | Freedom rank* | YTD % return | 3-year % annual return | 5-year % annual return | | iShares Austria (EWO, news, msgs) | 19 | 7.7 | 46 | 26.7 | | iShares Sweden (EWD, news, msgs) | 14 | 2.1 | 31 | - 1.8 | | iShares Australia (EWA, news, msgs) | 10 | 7.8 | 29.4 | 15.5 | | iShares Canada (EWC, news, msgs) | 16 | 11.1 | 28.8 | 5.3 | | iShares Singapore (EWS, news, msgs) | 2 | 13.1 | 21.2 | 4.4 | | iShares Hong Kong (EWH, news, msgs) | 1 | 9 | 18.6 | 2.1 | | iShares Germany (EWG, news, msgs) | 18 | 1.7 | 17.2 | - 1.6 | | iShares MSCI EAFE Index (EFA, news, msgs) | n/a | 1 | 16.5 | n/a | | iShares Switzerland (EWL, news, msgs) | 12 | 1.4 | 14.8 | 2.3 | | iShares United Kingdom (EWU, news, msgs) | 7 | 0.1 | 14.1 | 2.1 | | iShares Netherlands (EWN, news, msgs) | 17 | 3.6 | 11.6 | - 3 |
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Data as of 8/16/2005.
*From 2005 Heritage Foundation Index of Economic Freedom.
Sources: Heritage Foundation, Marotta Asset Management, MSN Money.
The reasons why a country gets a high freedom rank are as various as the conditions in each marketplace. Austria benefits from being the gateway between the West and the burgeoning economies of Eastern Europe. Canada has the strongest possible property rights and a shrinking public sector. Germany, despite huge labor costs, has a gilt-edged monetary policy and strongly protects the interests of foreign investors.
Some too small, some too hostile
Marotta's 10 choices don't perfectly reflect the Heritage Foundation's list because some markets, like Luxembourg and Estonia, are too small to invest in. Others, like Ireland, aren't represented by exchange-traded funds in the U.S. market.
Marotta's research only goes back to 2002 because the iShares MSCI EAFE Index fund was launched just a few months earlier.
The country funds have been around since 1996. All are managed by Barclays Global Investors, the world's foremost indexer.
Also excluded from Marotta's list are countries that are indifferent or even hostile to outside investors. That includes the hot China market. On a list where North Korea is worst, at No. 155, China ranks 112th. It has no effective property rights or legal system, makes foreign direct investment almost impossible and is nearly as rife with corruption as Russia.
Japan, No. 39 on the Heritage Foundation's list, has a banking system on the verge of collapse, incestuous corporate relationships that are more important than profits and politicians who prop up failed companies at public expense. It accounts for 23% of the EAFE index, second only to the United Kingdom. Eliminating it goes a long way toward upgrading a foreign-stock portfolio.
Free, but not conservative
Marotta believes so strongly in this thesis that he puts as much as half of client equity assets into foreign ETFs, and half of that into these single-country funds. The other half goes mostly into the iShares EAFE Index fund, which greatly reduces the volatility of the country bets, and partly into the iShares Emerging Markets Equity Index (EEM, news, msgs), to capture performance in fast-growing developing economies.
To implement his strategy, therefore, Marotta says you need an equity portfolio worth at least $160,000. Some $40,000 of that would go into these 10 funds, in the amount of $4,000 each, which Marotta says is the smallest increment that is economical to buy.
I think this is a very aggressive strategy -- much more aggressive than I would choose to follow in my own portfolio. For one thing, Marotta and I disagree over such basics as whether foreign stocks are a good all-weather place to be.
Marotta says: "Foreign markets have beaten U.S. markets all the time except the latter half of the 1990s -- and that was an aberration, not a trend."
I think that's stating things far too positively for foreign stocks. On a total-return basis since 1977, the EAFE index has beaten the S&P 500 ($INX, news, msgs) in 10 calendar years plus this year so far, or 36% of the time, according to Morningstar data. Over the last 15 years, EAFE is up an annual average of 2.6%, compared with the S&P 500's average advance of 10.9%.
Troubling trends at home
I will concede, however, that a number of economic trends in the United States are troubling and are already damping down our economic fire. Public-sector growth is accelerating as Republicans spend more freely than Democrats ever did. Our attitude toward foreign investors is racist. (Think China/Unocal recently and the Japanese in the 1980s.) Regulators are running amok with costly rules like Sarbanes-Oxley that proscribe activities that were already illegal.
And I certainly think now is a good time to be invested overseas. In my model portfolio of ETFs, I have 15% of assets in foreign equities. Earlier in the year, I had as much as 25% overseas and may have been too quick to trim that exposure.
Though aggressive, Marotta's funds are a good mix. Nos. 1 and 2 on the Heritage Foundation list, Hong Kong and Singapore, have five-year performance records vastly inferior to No. 19 Austria and No. 10 Australia. But this year, the two Asian markets are beating all but one of Heritage's elite countries, as well as trebling the returns of the domestic market.
If you want to try this, I think you need all 10 countries. That way you're diversified geographically, your foreign holdings behave less like your domestic funds and you avoid the most troubled regions.
A final note: Here are the top 10 and bottom 10 countries in the Heritage Foundation's rankings.
| Highs and lows in economic freedom | | Top 10 countries | Bottom 10 countries | | 1. Hong Kong | 146. Venezuela | | 2. Singapore | 147. Uzbekistan | | 3. Luxembourg | 148. Iran | | 4. Estonia | 149. Cuba | | 5. Ireland | 150. Laos | | 6. New Zealand | 151. Turkmenistan | | 7. United Kingdom | 152. Zimbabwe | | 8. Denmark | 153. Libya | | 9. Iceland | 154. Burma | | 10. Australia | 155. North Korea |
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Not included in the list: Angola, Burundi, the Democratic Republic of the Congo; Iraq, Serbia and Montenegro. Source: Heritage Foundation.
At the time of publication, Timothy Middleton owned none of the securities mentioned in this article.
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