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Time to shift your overseas investing
Small and mid-cap foreign stocks have been roaring, but that's about to change. Chase big caps to capture international growth this year.
By Timothy Middleton
Americans shoveled $8.47 billion into mutual funds that invest in small and mid-size foreign companies last year. Thats a surge of more than 40% from the record level of 2004.
Those investors were chasing performance. The average foreign small-company fund shot up more than 50% in 2003, 25% in 2004 and only a little less than that in 2005. U.S. stocks did about half as well.
Racing after yesterdays winners is risky, however. The hottest mutual funds, like the hottest stocks, frequently come crashing back to Earth after stratospheric leaps.
What to do if you've racked up big profits by owning those funds? Cut back. If you want to keep some money overseas, look first at funds that invest in fast-growing large companies.
An early exit
But foreign equities continue to look very good, in part because so much money is flooding into them. Investors poured a net $52.95 million into foreign large-company funds last year, according to Financial Research Corporation. Thats up 31.9% from the prior year.
Institutions like pension funds keep an average of about 5% to 10% of their overall investment portfolios in foreign stocks. But many Wall Street strategists think U.S. investors would be smart to keep 15% to 30% of their money overseas, says Lynette Schroeder, manager of Driehaus International Discovery (DRIDX). Her fund shot up 44% last year.
| Top foreign small-cap funds | | Top funds' annualized performance | 1 year | 3 year | 5 year | | Oppenheimer Intl Small Company A (OSMAX) | 33.7% | 47.6% | 19.2% | | Driehaus Intl Discovery (DRIDX) | 44 | 37.8 | 14.3 | | BlackRock Int Opportunity (BRESX) | 31.8 | 34.4 | 14.1 | | MFS Intl New Discovery A (MIDAX) | 20.2 | 30.5 | 13.7 | | Neuberger Berman Intl (NBITX) | 23.9 | 32.2 | 10.9 |
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Notes: As of 12/31/2005. List includes funds open to retail investors. Sources: MSN Money, Morningstar.
Schroeder says the assets of her fund, one of the best in the small- and mid-cap arena, have nearly doubled in the last year.
Superficially, foreign companies dont look so hot. Estimates are that European Union countries will eke out a 1.9% increase in gross domestic product this year, and Japan 2.4%. Both badly lag the U.S. consensus estimate of 3.3%.
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But its the growth trend, more than its absolute level, that interests investors, because they want growing earnings. The euro zone advanced only 1.4% last year, and Japan has been in the dumps for 15 years. U.S. growth is forecast to slow from 3.6% last year.
Economic growth, moreover, will benefit big-capitalization companies because they are more sensitive than smaller ones to macroeconomic conditions.
My moves to large-cap funds
So over the Christmas holidays, I pared my holdings of T. Rowe Price International Discovery (PRIDX), a small-cap fund, to about 6% of total assets, from 10%. If I hadnt also sold a portion a year earlier, that fund would have accounted for more than 15% of my portfolio.
I used the proceeds from that and some other portfolio pruning to boost my stake in growth stocks, both foreign and domestic. Overseas, I bought T. Rowe Price Japan (PRJPX), a big-cap growth portfolio. (I wrote about the fund here.)
I also boosted my position in T. Rowe Price International Stock (PRITX), likewise a big-cap growth fund.
My principal retirement account is with T. Rowe Price and I like these funds. But you should do your own due diligence. The table below lists the top-performing funds in the category.
| Top foreign large-cap funds | | Top funds' annualized performance | 1 year | 3 years | 5 years | | AllianceBernstein Intl Growth A (AWPAX) | 19.8% | 29% | 10.5 | | Quant Foreign Value I (QFVOX) | 15.4 | 30 | 16.2 | | Fidelity Intl Discovery (FIGRX) | 18.6 | 26.5 | 8.5 | | Bernstein Tax-Managed Intl (SNIVX) | 14.4 | 23.2 | 8.4 | | Vanguard Intl Value (VTRIX) | 18.0 | 26.1 | 8.3 |
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Notes: As of 12/31/2005. Selected noninstitutional funds open to new investors. Sources: MSN Money, Morningstar.
One of the maxims of investing is to cut your losses and let your winners run. But I prefer to keep positions within the bounds of what I consider good portfolio diversification. I would have made more money last year if Price International Discovery had been 15% of my portfolio. But I also would have been carrying more risk than I am comfortable with. That's even truer with small caps, which are prone to big price gyrations.
And, just as I was early a year ago, I could be very early in cutting back further on foreign small caps this year. But eventually I will be right -- markets move in cycles, as groups that are out of favor become cheaper and popular groups grow overpriced.
In the meantime, Im not going broke selling investments for 50% to 100% more than I paid for them. How I wish I had done that in 1999.
At the time of publication Timothy Middleton owned the following securities mentioned in this article: T. Rowe Price Japan, T. Rowe Price International Stock, T. Rowe Price International Discovery.
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