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How to Build an International Fund Portfolio by James D. Peterson, Ph.D., Vice President, Investment Manager Research, Schwab Center for Financial Research March 26, 2008 If you've traveled abroad the last few years, the weakening dollar may have caused you considerable pain. But investors in international equities have had reason to cheer: Over the last three years developed markets have risen 17% and emerging markets have soared 30%.1 In fact, a diversified equity portfolio—75% United States and 25% developed international—could have returned 10.7% over that time span, 2.1 percentage points more than a U.S.-only portfolio.2 While that type of toast-worthy performance may not continue in 2008, we believe you should keep a portion of your portfolio in international equities, no matter what the market conditions. Foreign stocks don't always move in lockstep with domestic stocks, which can reduce overall portfolio risk. And with nearly 60% of the world's market capitalization and over 70% of its gross domestic product (GDP) located outside the United States,3 the international market is just too vast to ignore. Currencies: To hedge or not to hedge? All else being equal, a weaker dollar enhances returns to an unhedged international fund because the same equity holdings denominated in foreign currencies are worth more in U.S. dollar terms. If you think that today's dollar will weaken further, we believe it's wise to stick with unhedged mutual funds—all the funds featured below are unhedged. How to build a well-balanced portfolio Our rule of thumb is to have one-quarter of your equity portfolio in international equities. But as in domestic markets, international markets vary widely. So, we've further segmented them into three categories: developed markets, emerging markets and international small-cap. The right mix will depend on your personal risk tolerance and preferences. To get started, see the chart below.  Start with a solid foundation Your international portfolio should be diversified across regions, countries, sectors and industries. An ideal starting point is a core fund with broad exposure to developed international markets. We like SSgA International Stock Selection (SSAIX) for its stock-picking skill. This fund beat the MSCI EAFE Index in six of the last seven years. Add a little emerging markets If you're willing to stomach more volatility, emerging markets offer a potentially powerful source of enhanced returns. Still, we'd suggest limiting emerging markets to a small slice of your long-term portfolio. Also, be careful not to double up. A fund doesn't need emerging markets in its name to have exposure to this volatile asset class. So be sure to know your funds' investment strategies. If you're looking for a pure emerging-markets fund to pair with a core developed-market fund, Lazard Emerging Markets (LZOEX) is a terrific choice to consider. LZOEX pursues a relative-value strategy, looking to temper risk by investing in financially solid companies that trade at a discount. And while LZOEX periodically lags the market in more cyclical upswings such as 2007, it has added outstanding value over the long term as evidenced by outperformance in seven of the past eight years. Prefer a single-fund solution? Consider Manning & Napier World Opportunities (EXWAX). With less than 15% of the fund in emerging markets and an aversion to countries without strict market regulation—which the manager believes adds unnecessary risk—this diversified international fund is a good option. EXWAX outperformed the EAFE in eight of the last 11 years. Layer in some small-caps and mid-caps Historically, international small-cap and mid-cap stocks have been the least likely to move in tandem with domestic stocks. Hence, they're a potentially powerful diversifier, though they can be volatile, so we suggest limiting exposure to 5% of your equity portfolio. These markets also tend to offer better opportunities to outperform, giving smaller-cap managers an edge over their large-cap peers. Our favorite is American Century International Discovery (TWEGX), which seeks above-average earnings growth by focusing on momentum stocks of small- and mid-cap global companies (less than 10% in emerging markets). The fund’s opportunistic process has yielded three-year outperformance over the MSCI EAFE Small Cap Index of 10.9%. Still daunted? Your Schwab consultant can always help. Also, consider Schwab Managed Portfolios™, which take a similar approach with the international portion of their portfolios, and include domestic and bond funds as well. Or check out the Mutual Fund OneSource Select List® for other ideas. Important Disclosures Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing. Investment value and return will fluctuate such that shares, when redeemed, may be worth more or less than original cost. Performance quoted is past performance and is no guarantee of future results. Returns could be higher or lower. See Schwab.com for recent monthly performance. 1-, 5- and 10-year returns (%) as of January 31, 2008: SSAIX — –4.1, 21.6, 7.7; LZOEX — 25.1, 36.4, 14.6; EXWAX — 5.2, 21.4, 13.1; TWEGX — 8.3, 27.8, 15.6; MSCI EAFE — 0.6, 20.8, 7.5. Approximately 2,100 funds participate in the Mutual Fund OneSource® service. Only these funds, including Schwab Affiliate Funds, are eligible for the Mutual Fund OneSource Select List®. Schwab receives remuneration from fund companies, and/or their affiliates, in the Mutual Fund OneSource service for recordkeeping, shareholder services, and other administrative services. Please read Schwab's Schedule H of Form ADV for important information and disclosures relating to Schwab Managed Portfolios™. 1. Developed international markets represented by MSCI EAFE Index Net of Taxes and emerging markets represented by MSCI Emerging Markets Index Net of Taxes. 2. U.S. stocks represented by S&P 500® index and international stocks represented by MSCI EAFE Net of Taxes. 3. World Federation of Exchanges, Bloomberg, December 2006. This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security or investment strategy. Schwab does not assess the suitability or the potential value of any particular investment or investment strategy. All expressions of opinion are subject to change without notice. The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc. All research has been compiled from publicly available, proprietary and/or licensed data. Past results are not indicative of future performance. Diversification and asset allocation do not eliminate the risk of investment losses. International investments are subject to additional risks, such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks. Small-cap stocks have historically been more volatile than the stocks of larger, more established companies. The S&P 500® index is an index of widely traded stocks. Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly. The MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the U.S. and Canada. As of June 2006, the MSCI EAFE Index consisted of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom. (0308-3975) Return to Top |
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