Foreign investing no haven in U.S. crisis

Believers in foreign investing might have thought exposure abroad would limit their losses after terrorists struck close to the heart of Wall Street.

But unless those investors placed big bets in Switzerland, international diversification hurt more than it helped.

That’s one more reason why investors – and their financial advisers – should rethink allocating money in foreign funds, says Thomas Laming, senior vice president of Kornitzer Capital Management Inc. in Shawnee Mission, Kan.

“You might think that you would have been better off being in European stocks last month than the U.S., because we just had our way of life attacked,” says Mr. Laming, portfolio manager for the Buffalo Funds, a six-fund group run by Kornitzer Capital.

“Some people say that’s a reason to be diversified outside of the U.S., but I’m hard-pressed to find any market that wasn’t down more than the U.S.,” he says.

no escape

Examining the major world indexes from Sept. 10, the day before the terrorist attack, through Sept. 21, nearly all exceeded the 11.60% decline of the Standard & Poor’s 500 stock index. The exceptions were the Swiss Market Index, down a currency-adjusted 10.83%, and the already battered Nikkei, down 2.70%.

“It just underscores that huge correlation between our market and the rest of the world,” says Mr. Laming.

However, others don’t believe it’s prudent for investors to give up on international investing just because it didn’t provide a haven during an American crisis.

“Over any period of time, markets will go up or down. But even though they are relatively highly correlated, they don’t perfectly go up and down together,” says Roger Ibbotson, chairman of Ibbotson Associates in Chicago and a professor at the Yale University School of Management.

“You get far more diversification benefits by adding another country to your portfolio than you do adding another stock to your portfolio.”

Mr. Laming argues to the contrary in his recent white paper.

For example, returns on international stocks have lagged those on U.S. stocks for more than 31 years, he says. A $1,000 investment in both the S&P 500 and the Morgan Stanley Capital International Europe, Australasia and Far East index – started in 1970 – would have grown to $36,456 and $24,029, respectively, by end of the first quarter of the year.

Also, the correlation between the S&P 500 and the EAFE index has increased in the last few years, weakening the case for foreign stocks.

“To automatically accept that international investing is a way for you to decrease risk in your portfolio and hopefully enhance returns just doesn’t seem to hold water,” says Mr. Laming.

He thinks investors can benefit from the potential growth in foreign markets by investing in U.S. companies that do significant business abroad. That’s the basis for Mr. Laming’s Buffalo USA Global Fund, which had fallen 24.47% year-to-date as of Sept. 27, compared with 27.86% for the EAFE index.

Commenting on the white paper, Mr. Ibbotson agrees that the correlation between the U.S. and world markets has increased, which means the “benefits of international investing are not as great as they had been.”

And during crisis periods, such as the aftermath of the terrorist strikes or the market crash of 1987, world markets tend to go in the same direction.

“But even when you’re in a crisis, [the indexes] are falling by different amounts, and having a mixture of that would tend to reduce your volatility,” says Mr. Ibbotson.

Morningstar Inc. reports that only two foreign funds – the Morgan Stanley Institutional International Equity Portfolio and the Putnam International Growth Fund – beat the S&P 500 over a 10-year period.

Mr. Ibbotson attributes that to a great run in the U.S. markets in the 1990s. Foreign markets, on the other hand, did better in the 1980s, he says.

“The benefit of diversification is that you are going to average out among all these winners, so you’re not going to be the loser,” says Mr. Ibbotson.

Robert Markman, an adviser with Markman Capital Management Inc. in Edina, Minn., stopped using foreign funds in 1997.

“When everything is fine, the deck is stacked in favor of the U.S.,” says Mr. Markman, who manages $300 million. “When everything is lousy, foreign markets don’t do much better – or do even worse.”