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Why do investors buy world-stock funds? The idea behind them -- and presumably the reason why they've attracted more than $100 billion in assets -- is easy to understand. Simply put, they give investors broad exposure to the entire equity universe. One half of the world's market capitalization sits in foreign-based companies, so world-stock funds are designed to allow portfolio managers the flexibility to find the best opportunities, wherever they might exist.
The problem with world-stock investing is also simply put: World-stock funds typically don't look much different than U.S. large-cap funds, but the average world-stock fund has underperformed the average U.S. large-cap fund. To add insult to injury, they provide such lackluster results at significantly higher expense to shareholders.
Most world-stock funds are heavily oriented toward large multinational corporations. Morningstar's latest data show that the following firms are world-stock fund managers' favorites (listed in order of popularity): Altria Group (MO, news, msgs) (the renamed Philip Morris), Pfizer (PFE, news, msgs), AstraZeneca (AZN, news, msgs), Citigroup (C, news, msgs), Tyco (TYC, news, msgs), Clear Channel Communications (CCU, news, msgs), Microsoft (MSFT, news, msgs), Nestle (NSRGY, news, msgs), Pharmacia (PHA, news, msgs) and Samsung (ticker not available).
U.S. companies dominate the holdings
Seven out of 10 are American-based corporations and the other three are globally situated giants. The top-10 list for large-blend funds isn't that different: Microsoft, General Electric (GE, news, msgs), Citigroup, Exxon Mobil (XOM, news, msgs), Pfizer, American International Group (AIG, news, msgs), Wal-Mart Stores (WMT, news, msgs), Johnson & Johnson (JNJ, news, msgs), Altria Group and Intel (INTC, news, msgs). Four names overlap with the world-stock top 10 and the rest are also global giants in similar industries.
Given that overlap, it's not surprising then that the two investment categories nearly mirror one another in terms of performance. The statistical correlation, or R-squared, over the past three years between the average world-stock fund and the average large-blend fund is 90--not a perfect 100, but pretty close.
World-stock and large-cap U.S. funds tend to move together, but the former have generally delivered worse results over the long haul. While their five-year records are roughly equivalent, U.S.-only funds have gained on average about 9% over the past decade, while the typical world-stock offering is up only about 6.4%. That's partly because foreign markets have generally underperformed the U.S. markets during that span.
Pricier than U.S. funds
But it's also because world-stock funds cost significantly more than U.S.-only funds. The average no-load, large-cap world-stock fund costs 1.32% annually while the average yearly price tag for a no-load large-blend fund is 0.83%.
Is that added expense justified? On the whole, we don't think so. That's less because of the sub-par performance than it is because, as we demonstrated above, large-cap world-stock funds own a lot of the same easily researched, highly liquid, global mega-caps held by standard U.S.-only offerings. While world-stock managers might justify the added expense with reference to their global mandate, we don't buy it. Researching and trading Pfizer and AstraZeneca involves the same process at roughly the same cost. Same for Exxon Mobil and Royal Dutch Petroleum (RD, news, msgs), Intel and Samsung, or American International Group and ING Groep (ING, news, msgs).
Of course, some world-stock funds are managed more capably than others. That's why Morningstar assembles its Fund Analyst Picks list for the world-stock category. Some smart stock-pickers, such as Bill Wilby of Oppenheimer Global (OPPAX) or the portfolio team at American Funds New Perspective (ANWPX), have added shareholder value during their tenures. But we'd caution most investors forgo the category. Although it involves an extra step, we suggest investors manage their own global asset allocation by buying a pure foreign-stock vehicle in addition to a core U.S.-focused holding.
Copyright 2003 Morningstar, Inc.
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