INDEX FUNDS FOR FOREIGN COUNTRIES NEXT IN LINE: CALIFORNIA FIRM READIES 10 FOR SEC REGISTRATION

Hoping to extend indexing mania to the international realm, a California mutual fund firm appears to be laying the groundwork for a set of international index funds targeted to specific countries, according to investment advisers the firm has tapped for advice.

Watermark Capital Ltd., a new mutual fund company in Pasadena, could register as many as 10 funds with the Securities and Exchange Commission within the next few months. If Watermark follows through — it won’t comment on its plans — it would be the first firm to offer retail investors a broad range of single-country index funds.

That could allow long-term investors to focus their international bets beyond broad regional open-end funds. It also could attract the opposite: market timers who hop from country index to country index in search of the next hot thing.

Watermark and other small mutual-fund companies are looking for niche plays under the sights of the industry’s big indexing guns. For instance, Rydex Series Trust hopes late this year or early next to unveil a batch of international index funds, although the Rockville, Md., firm hasn’t settled on particulars.

The two companies would be picking at the scraps left by the titans of the international indexing market: Vanguard Group and Dimensional Fund Advisors.

Valley Forge, Pa.-based Vanguard offers four international index funds, which track Morgan Stanley Capital International’s European, Pacific and emerging markets indexes, as well as a portfolio that combines the three. Together, the funds have about $5.6 billion in assets.

DFA, based in Santa Monica, Calif., offers nine international index funds, six of which have a small-cap focus. They invest in Pacific Rim and European markets.

Neither Vanguard nor DFA intends to develop country-specific index funds. Vanguard spokesman John Woerth cites “the risk involved in concentrating your assets in a single country. Indexing is a strategy that works best with broad diversification.”

Of course, the narrower funds’ poten
tial appeal for advisers who want an international component in their clients’ portfolios is the ability to avoid countries with souring economies.

not a popular choice

Because investors feel active managers have a better chance of outperforming the less-efficient foreign markets, observers say, indexing hasn’t taken hold with investors in international equities the way it has with those who traffic in U.S. stocks.

Net inflows into international index funds fell last year to $711 million from $985 million in 1996, according to Boston-based Financial Research Corp. As of Jan. 31, assets in international index funds stood at $6.1 billion.

By contrast, funds indexed to the S&P 500 saw a whopping $20.9 billion in inflows last year, up from $16.9 billion the year before. Assets in S&P index funds topped $113 billion as of Jan. 31.

Still, in the lucrative world of running mutual funds, a product gap doesn’t stay unfilled for long. The fledgling Watermark Capital — launched by F. Brian Cerini, former president and chairman of the $3 billion-plus Sierra Trust Funds — apparently has identified country-specific index funds as one such gap.

Mr. Cerini wouldn’t comment on his new company’s plans, saying only, “The international marketplace certainly has a lot of potential.”

But Watermark has approached the Zero Alpha Group, made up of investment advisers committed to indexing and long-term asset allocation, to probe the potential demand for single-country index funds, say two advisers with the group.

“I’m interested,” says Brent Brodeski of Savant Capital Management Inc., a Rockford, Ill.-based fee-only adviser with $135 million under supervision. “It would be nice to have some other names out there.”

That sentiment was echoed by Jeffrey Buckner of Chesterfield, Mo.-based Plancorp Inc., who is skeptical that Watermark will be able to keep expense ratios low and worries about the ease of rebalancing portfolios as various country indexes rise and fall.

market-timer territory

To date, country-specific portfolios have been a favorite of the Zero Alpha Group’s polar opposites — market-timing advisers, who dart in and out of funds as economic conditions change.

At least, that’s been the experience of Wright Investors’ Service, which offers 10 actively managed single-country funds. In the seven years since the Bridgeport, Conn.-based money manager began offering the single-country EquiFund portfolios, the funds have attracted unwanted market timers more than they’ve attracted assets.

The firm briefly imposed a 30-day back-end charge to discourage timing before abandoning that approach about a year ago after inflows slowed. (The 10 funds combined have just $60 million in assets).

But not all the signals are negative. The 17 single-country “baskets of stock” that trade on the American Stock Exchange as World Equity Benchmark Shares, or WEBS, have seen daily trading volume more than double in the last year to just over 1 million shares.

The baskets — launched two years ago by the exchange, Morgan Stanley and Barclays Global Fund Advisors — are shares in groups of stocks designed to replicate Morgan Stanley Capital International’s various country indexes, which collectively make up the benchmark Europe-Australasia-Far East index.

Despite the success, Michael Byrum, a Rydex vice president, says his company has all but ruled out single-country funds and is likely to take a more regional approach when it develops international funds.

“When you try to break it down that finely and there are no ground rules on trading,” he says, “there are liquidity problems.”