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Foreign fund insight
Foreign funds roar past war and SARS
Neither war nor illness has been enough to derail foreign markets in 2003.
By Emily Hall
After several years of largely dismal returns, international funds are on a tear lately. For the first half of the year, most international-equity categories posted double-digit gains. International-bond and emerging-markets bond funds also shined.
It hasn't been a smooth ride, however. The first few months of 2003 were rocky, with war fears and concerns about the spread of SARS and Korean nuclear tensions holding markets down. But strong gains came after the U.S.-Iraq war proved short-lived, even though the other worries didn't evaporate.
Is it the real thing?
Is this just a dead-cat bounce or does the rally in overseas markets have legs? It's very difficult to say.
Global growth remains quite sluggish, especially in some developed markets. Germany is teetering on the brink of recession, and despite some mildly positive recent signs, Japan's economy remains mired in a dismal state. And the economic woes that drove Brazil and Argentina into distress have abated but certainly still exist.
But the news isn't all bad. Strong growth in China has led some investors to look at Asian companies that export heavily to the mainland, as well as Chinese shares themselves. Moreover, a rallying euro has helped boost the gains of unhedged funds that invest a good portion of their assets in European names.
Finally, many money managers continue to mention the compelling valuations they're finding outside of the United States, since many bourses overseas never rallied quite as aggressively as the American markets did in the 1990s.
Emerging-markets bonds
One area that deserves particular mention for its outstanding performance is the emerging-markets bond category. In general, emerging-markets bond funds have been fantastic performers for nearly half a decade: The typical offering has posted an astonishing annualized gain of 10.9% over the trailing five years.
In 2003, the enthusiasm for emerging-markets bonds was driven by several factors. Some countries, such as Russia, continue to demonstrate economic and fiscal improvements, which increase the appeal of investing in their government debt. And fears that Brazil's new leader would turn the country sharply leftward -- which drove Brazil's debt down sharply in 2002 -- proved unwarranted, leading to a huge rally in the country's bond market.
More generally, the extremely low yields in the United States, Japan and Europe simply led global investors to search for higher payouts wherever they could find them. However, investors should think carefully before adding an emerging-markets bond fund to their portfolios. It's always dangerous to chase performance in any category -- and this category has been on quite a spectacular run.
Moreover, this is a particularly risky asset class -- those higher yields are offered for a reason. In fact, emerging-markets bond funds can be intensely volatile, with standard deviations (risk measures) that look more like stock offerings than bond funds. Retired investors or others worried about capital preservation should probably avoid emerging-markets bond offerings altogether.
Maintaining diversification
Overall, though, the recent rally in international stock and bond funds serves as a reminder to maintain a diversified portfolio that includes exposure to overseas markets, even if they haven't performed well at a particular time.
To avoid the problem of trying to guess which region is going to outperform, an excellent way to gain such exposure is through a broadly diversified foreign-stock fund -- especially a low-cost offering. Consider looking at our Fund Analyst Picks in the foreign-stock category if you don't know where to start your search.
(c) Copyright 2003. Morningstar, Inc. All rights reserved.
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