Foreign stocks hit with one-two punch

Advisers are struggling to deal with clients’ exposure to foreign stocks.

While the Standard & Poor’s 500 stock index was off 35.02% year-to-date through last Thursday, foreign markets had done even worse. The MSCI EAFE Index was down 44.74%, and the MSCI Emerging Markets Index was off 54.93%.

“[Foreign markets are] getting clocked,” said Ken Safian, president of Safian Investment Research Inc. in White Plains, N.Y., which manages about $1 billion.

Not only are foreign markets selling off, but U.S. investors are losing even more because of the strong dollar, he said.

The dollar hit bottom against foreign currencies last spring and took off with a vengeance in July.

“That’s why we’re seeing such a tremendous hit,” Mr. Safian said.

SHOCKED BY THE SPEED

Even those who expected the dollar’s long-term decline to end “were shocked by the speed and amount of [its] rise,” said Gregg Wolper, a senior mutual fund analyst with Morningstar Inc. of Chicago who covers foreign and emerging-markets funds.

“This certainly is not a happy time” for investors in foreign funds, he said.

“People didn’t realize that the extra 5% per year they were getting [from foreign stocks since 2003] was from currency movements,” said Chris Channer, founder of Channer Investment Management Inc. of Inverness, Ill., who manages $150 million.

“But once it swings the other way, you can lose 5% going the other direction. Most [investors] don’t understand that,” Mr. Channer said.

Weakness in international markets has put a noticeable dent in many portfolios. Many advisers allocate up to 30% to foreign equities.

A portfolio allocated 20% to bonds has underperformed the broad U.S. averages if the equity portion contains foreign stocks, said John Robinson, a registered representative who is managing director at Hawaii Wealth Management in Honolulu.

POOR PERFORMANCE

“You can attribute that [underperformance] to international exposure,” he said.

Mr. Robinson recommends investors have up to 25% of their equity allocation in foreign stocks. He said he managed $475 million at the start of 2008.

“Even those [foreign funds] that are considered among the best, like [the Global Stock Fund and the International Stock Fund, from] Dodge & Cox [Funds of San Francisco], are down 50% or 60%” year-to-date, which makes it tough for investors, Mr. Channer said.

Observers say the market’s crash will have to reverse at some point. But they worry that investors may not be in the mix to enjoy the rebound in hard-hit international markets.

“There’s been money flow out of all [mutual] funds, including international funds,” Mr. Wolper said.

World equity funds lost an estimated $33.8 billion in August and September, according to Lipper Inc. of New York. That contrasted with positive net flows totaling $7.8 billion for U.S. stock funds over those two months.

U.S. stock funds held $2.7 trillion at the end of September, more than double the $1.2 trillion in world equity funds.

Making matters worse, many investors came into foreign markets late.

A “substantial percentage” of single-country emerging-markets funds, for example, came out be-tween 2005 and mid-2008, Mr. Wolper said in a recent report.

“As so often happens, people pay attention to what has performed well lately, so some [investors] got in at the tail end” of the rally in foreign markets, he said.

For their part, advisers have been urging clients to stay the course with their foreign holdings — and actually urging investors with cash and fortitude to increase their stakes.

“We haven’t been reacting” to the meltdown in overseas markets, Mr. Robinson said.

He’s kept his client allocations constant, and most of his accounts re-balance automatically.

But due to the worldwide sell-off, advisers have had to hold clients’ hands.

And they’ve had to explain again why riskier assets such as foreign stocks belong in portfolios.

Mr. Robinson has been sending clients a string of e-mails, which he also posts on his website, warning against the temptation of trying to time the market, and discussing the evidence backing the diversification benefits of modern portfolio theory.

“I’ve addressed the situation with … foreign [stocks’] being down more than the U.S.,” he said.

Most of his clients have been with him for many years and understand his diversified approach, he said.

But the “dramatic successive market declines” have caused an “emotional strain” that is “palpable in people’s voices and demeanors,” he acknowledged in an update to clients last month.

“We just had a meeting for 200 of our clients” about market conditions in general, said John Merrill, president of Tanglewood Wealth Management Inc. of Houston, which manages $600 million in assets.

The hourlong presentation and another hour for questions allowed “us to see how they felt,” he said.

Clients are concerned, he said, but only three out of 400 clients have gone to cash.

For the rest, Mr. Merrill recently increased their holdings in foreign stocks. His clients’ portfolios had been underweighted.

“We bought the [EAFE index] last week,” Mr. Merrill said. The values are “just amazing,” he said, noting that stocks in the EAFE index are yielding around 6%.

“That’s a real cash dividend,” Mr. Merrill said, not an earnings figure that can calculated a number of ways.

“A huge part of Europe is selling at single-digit multiples,” he added.

Mr. Channer’s advice is the same.

“Buy more” foreign stocks, he said. “I’m serious,” Mr. Channer said.

E-mail Dan Jamieson at [email protected].