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The herd gets it wrong – again

Richard Loth

As I have pointed out in previous columns, on Sept. 1 and June 29, fluctuating exchange rates can both help and hurt international investment returns. Last year, and up until the first part of 2005, the weakening U.S. dollar provided an extra boost to foreign stock investing, which was enthusiastically encouraged by many investment advisers and given big play in the financial press. American investors bought foreign stocks and stock mutual funds at a record pace.Guess what has happened in the past few months? The U.S. dollar has strengthened and the experts appear to generally agree that it should stay fairly strong well into 2006. This means that regardless of the fundamental value of foreign investments, when these get translated (or exchanged) back into greenbacks, investors will be looking at diminished returns.The Wall Street Journal’s Jeff Opdyke recently sub-titled an article on international investing this way: “Some Investors Start to Rethink Their Exposure to Foreign Funds as U.S. Currency Rises.” Among others, he cited prominent financial companies such as J.P. Morgan Chase, Standard & Poors and Wachovia as advising their clients to reduce their international stock exposure fairly significantly.Richard Madigan, investment strategist at J.P. Morgan Private Bank, was quoted as advising the firm’s high-net-worth clients to “cut back their investments in foreign currencies dramatically.” “The risks don’t justify the reward right now,” Madigan said. As usual, the mass of retail investors is behind the information curve, and the “herd instinct” keeps them moving in the wrong direction. Opdyke observed that “even as the dollar gains ground, retail investors are continuing to go overseas.” In addition to the many billions of dollars that went abroad last year, AMG Data Service of Arcata, Calif. reported that investors have put an additional $43.6 billion into international stock and bond mutual funds in 2005.While I admit to being somewhat of a contrarian when it comes to international investing, I agree that most portfolios should have some foreign investment component. But I take issue with those in the investment advisory community that push retail clients toward foreign stock/bond investments in the 25 percent to 35 percent range of their total holdings. The current institutional investor’s target allocation is 13 percent.I generally recommend foreign commitments in the 10 percent range as appropriate for individual investors. In addition, keep the exposure as broad-based as possible through mutual and exchange-traded funds such as Dodge & Cox International (DODFX), Vanguard Total International Stock (VGSTX), Merrill Global Allocation (MDLOX), and iShares S&P Global 100 Index (IOO). Lastly, international investing has to be considered a long-term proposition primarily motivated by the objective of increased diversification and not opportunistic profits from currency movements.Fund investors also should remember to look at the percentage of assets of a fund’s portfolio invested in foreign securities. Many “domestic” mutual funds carry significant international exposure, which indirectly provides the fund shareholder with participation in foreign markets.For example, a sampling of some of the largest mutual fund portfolios shows the following foreign stock percentages: American Growth (AGTHX) – 16 percent, Fidelity Contrafund (FCNTX) – 20 percent, and Dodge & Cox Stock – 15 percent. And, while the Vanguard 500 (VFINX) is purely domestic, many of its large, multi-national companies like GE, Citigroup, Coca-Cola, ExxonMobil, etc. generate a large percentage of their earnings from foreign operations. It’s fair to say that an investor can get a lot of international action by staying close to home with these types of stocks.There’s no need to be overly concerned at this time about liquidating quality international investments currently in your portfolio. However, if you’re getting the itch to run with the herd of investors rushing abroad, I’d advise against doing so – you’ll be headed in the wrong direction.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing and an independent registered investment adviser. Loth can be reached at 827-5591 or mentorinvesting@comcast.net.Vail, Colorado


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