01/25/2002

What About the International Markets?

In over three years of writing articles for SNET.net, I have never directly addressed international investing. However, I continue to meet with people that hold relatively large portions of their portfolio in international funds, mostly based on decisions made years ago regarding diversification. Now they are questioning this mix and the future of international markets. Given that the current issue of the Waddell & Reed Advisor newsletter has a good article on the subject, I thought I would share a slightly condensed version for easier reading:

Is now the time to "internationalize" your portfolio?

Adding international equities to your portfolio as a diversification measure was popular among investment experts just a few years ago. In today's economy, is it still wise to "internationalize" your portfolio?

The trend to add international investments to one's portfolio began in the 1970s when a weakened US dollar and an extended bear market made it profitable for investors to look elsewhere. Though the US economy recovered in the 1980s, flourishing markets in Japan and Western Europe kept this trend alive.

International investing remained one of the fastest growing asset categories in the 1990s. However, by mid-decade, investors saw fewer and fewer benefits in holding international securities. The reasons: first the US dollar took considerable strength over the euro and other international currencies, making it less attractive for American investors to send their money abroad. Between 1996 and 2000, the US dollar appreciated by almost 25 percent. And, over the decade, the US stock market dramatically outperformed foreign benchmarks. Annualized returns for the S&P 500 index from 1991-2000 more than doubled returns earned by EAFE (Europe, Australasia, Far East) portfolio.*

If one were to compare a chart of the EAFE and the S&P 500 since 1974 you would note two aspects of the relationship between domestic and international stock performance. In most years, these indexes have moved in opposite directions, truly providing diversification to investors. In recent years, however, US markets and international markets have often moved in tandem—discounting any benefit of having international investments. The chief investment officer of Waddell & Reed Investment Management Co., Hank Herman, has attributed this recent parallel in performance to the large influence of the US economy on the global economy. "Since 1997, as much as 40 percent of the world's non-US economic growth has been directly attributable to exports to the United States" he said.

So where does that leave investors looking to decide on international portfolio holdings? Many analysts still believe there is a case of some international holdings.

According to Hermann, "The dollar has been in a steep upturn relative to other currencies for more than five years. At some point, this overvaluation may lead to a weakening dollar. If the dollar goes down, the value of international investments increases." Over the next three years, the value of the US dollar is expected to depreciate 20 percent against other currencies.**

Furthermore, some analysts believe Europe may prove more attractive for international investors. With equities often less expensive than those in the US, Europe has resilient consumers and a currency that is expected to rise. Important restructuring in Europe and more open markets could accelerate profit growth, thus helping the relative performance of European markets.

In Summary

Over the long term, keeping a portion of your portfolio invested internationally could potentially help lower the overall volatility within your portfolio and enhance returns. However, note that the analysts seemed to like Europe, but not many seem to be big on Asia with Japan stuck in its economic doldrums. So take a look at your international mutual funds and see if they are more European based. You will also want to assess what percentage you have in international holdings, making sure you have a portion that is comfortable with your risk tolerance. Remember, it is quite possible that the US market just may bounce back before any international market does.

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Author's Note: Please note that international investing involves additional risks, including currency fluctuations, changing political or economic conditions and differences in accounting standards.

Waddell & Reed, based in Overland Park, Kansas, has been in the financial services business for over 60 years. Today, Waddell & Reed has grown to more than 200 offices nationwide. Waddell & Reed can be accessed on the Internet at waddell.com. There are two offices in Connecticut: North Haven and Hartford.

*Business Week Online, Sept. 10, 2001
**Business Week Online, Sept. 28, 2001

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Please send questions or comments to dcoffin46333@wradvisors.com.