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Giving Portfolios a Global Spin : Overseas Stocks, Funds Can Boost Your Returns--but Beware of Currency Swings

10 Things Every Investor Needs to Know: 7. How to use international stcks.

December 10, 1996|KATHY M. KRISTOF

Here's an exercise for those who think they don't need foreign investments in their portfolio: Look at the labels on your possessions. Are they all made in the United States, or do they take on an Olympic flavor? Perhaps your clothing hails from Mexico or Taiwan, your car comes from Europe and your electronics from Japan.

Those foreign labels should signal two things to you as an investor: One, to maintain your current buying power, you need a certain amount of international exposure, says Donald Gould, president of San Mateo, Calif.-based Franklin Templeton Global Trust. Two, there are some great companies producing world-class products overseas. That spells opportunity.

"It used to be that the U.S. dominated the world economy, so it was appropriate for U.S. investors to ignore the rest of the world," says James J. Atkinson Jr., director of Guinness Flight Global Asset Management Ltd. in Pasadena. "But you can't make that claim anymore."

Indeed, though the U.S. stock market remains the biggest in the world, foreign markets now account for about 60% of the world's stock market capitalization, notes Mark Geist, president of Montgomery Asset Management in San Francisco. Concentrating all your dollars in the domestic markets means you're ignoring 60% of the world's investment opportunities, he says.

"We are in an environment of global companies, global distribution and global consumerism," Geist adds. "Every investor should have a portion of their portfolio invested globally too."

But what may be the most compelling reason of all to invest in foreign markets is this: A host of independent studies suggests that international investments have had an unusual effect on diversified portfolios. They reduced the overall risk and modestly increased the potential return, says James E. Andelman, consultant with Ibbotson Associates in Chicago.

Historically there has been little link between the performance of U.S. and foreign stock markets, says Andelman. In other words, when U.S. stocks are rising, foreign stocks could be falling, and vice versa.

Because the markets can move at different times and at different speeds, foreign stocks can smooth out the bumps in your domestic portfolio. That does more than save you money on antacids. It actually improves your portfolio's performance over time. Even as world economies become more interdependent and inter-related, many analysts think this state of affairs is likely to continue.

But even the biggest advocates of foreign investments agree that they are best taken in moderation, because many foreign markets are more volatile than U.S. markets. In addition, currency risk can magnify these swings.


What is currency risk? All world currencies--whether U.S. dollars, French francs, Japanese yen or German marks, for example--fluctuate in value when measured against one another. When you buy stock in a foreign company, you buy the shares with that country's currency, after converting dollars to the currency at the going exchange rate. When you sell, you get paid in that country's currency, and you then must convert that currency back to dollars, at the going exchange rate.

If the exchange rate is significantly different between the time you buy and the time you sell, it can add to--or reduce--whatever return you earned on the stock itself. In some cases, the change in currency values can be more significant to your total return than the actual appreciation or depreciation of the particular stocks you purchased.

If the dollar weakens in value against another currency, you make money on the currency exchange, because each unit of foreign currency translates into more dollars. If the dollar strengthens against another currency, you lose on the currency exchange because each unit of foreign currency translates into fewer dollars.

To illustrate, consider a hypothetical individual, John, who invested $10,000 in Japanese stocks in April 1995--a time when the Japanese yen was at record strength against the dollar--and sold in October 1996.

When John bought, his $10,000 was converted into 843,000 yen worth of stocks, because $1 equaled 84.3 yen at the time. In yen terms, his stocks then appreciated a solid 20% over the period as the market rose, making the securities worth 1,011,600 yen when he sold.

But in the same period the dollar strengthened considerably against the yen; instead of 84.3 yen needed to equal $1, it took 114 yen to equal $1 when John sold. So after converting his yen to dollars, John came home with just $8,874--a $1,126 loss, caused solely by currency swings.

On the other hand, U.S. investors who bought Japanese stocks at the end of 1990 still have a positive return--even though the Japanese market is well below its 1990 levels--because the dollar's value has weakened significantly since 1990, from nearly 140 yen then to about 113 now.


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