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How to invest internationally
Deena Katz, Outlook Money | August 24, 2006
A couple of months back I sat down with a woman to discuss her current portfolio and how she might reposition. As soon as I mentioned diversification she became defensive. "I am diversified," she explained, "I own 14 different mutual funds."
She did indeed own 14 funds, but all of them were invested in large US company stocks. I showed her the top 10 holdings in each fund. "Look," I said, "Each of these funds owns most of the same stocks. This overlap in holdings puts you more at risk than you should be. Owning 14 different funds of the same thing isn't diversification. If you are going to own different mutual funds, make sure that you invest in different asset classes and styles. Ideally, a well diversified portfolio should have some international exposure."
She pondered over this for a moment, and then brightened. "I own Coca-Cola in all my funds. They sell Coke worldwide, don't they? Won't that mean I have invested internationally?"
Unfortunately, research shows that owning a domestic stock, no matter how global the operation, does not give you the same diversification advantage as owning non-domestic company stocks.
To get the best diversification impact, you can invest in different countries and, in different types of companies within those countries.
Now that investors in India will have an opportunity to invest in overseas markets through the mutual fund route, you should re-evaluate your portfolio and discuss options with your advisor.
Because in some months you will have many types of funds to choose from, here are some tips on how to select the best fund. In the US we have actively and passively managed mutual funds. An active manager may follow as few as 20 or 30 stocks and concentrate on one asset class or one sector.
Active managers have documented buy and sell disciplines, they manage their funds to beat the market returns and add alpha (a measure of a manager's value) to the returns. Passive managers attempt to replicate the market they invest in.
For example, an S&P 500 fund will invest in the 500 largest companies in the US. A non-US international index fund may replicate the EAFE (Europe, Australia, Far East) index. An EAFE fund invests in large companies in developed countries. Since this may be your first foray into the overseas markets, try to get your non-domestic diversification from an index or passive fund, rather than bet on the expertise of an active manager.
If you invest in more than one active manager, make sure there is no overlapping of securities. More funds in your portfolio do not necessarily translate into more diversification.
Once you have selected your manager, get a clear picture of what it will cost you to be invested in the fund. Ask your advisor what the expense ratio of the fund is. An expense ratio reflects the administrative costs and management fees involved in running the fund.
This will be the annual charge that you will pay as long as you are in the fund. While active funds are more expensive than passive, it does not necessarily mean that you will not receive value for paying more. A good conversation with your advisor can clarify what the ongoing costs and benefits will be.
Expect to invest overseas for the long run. Choose your core fund, preferably an index, and then as you invest more internationally, begin to build around that investment with additional funds that may have a unique style or exposure to a different market with active managers.
If a fund is not performing as you had expected, be certain that you know how that asset class is performing as a whole. It may be that the asset class is out of favour at the moment.
Finally, remember the basic tenet of asset allocation: If at least one of your funds isn't losing, you may not be diversified enough.
The author is president, Levitt & Katz