csua.org/u/ahm -> www.latimes.com/business/la-fi-foreign20dec20,0,1745337.story?coll=la-home-business
By Tom Petruno, Times Staff Writer Already depressed by the nation's huge budget and trade deficits, the US . dollar is being undermined by American mutual fund investors: More of them are funneling money into foreign stock funds, a shift that hurts th e greenback. Thanks in large part to the dollar's weakness, returns on foreign shares overall have significantly outpaced US market returns since 2002. Fore ign stock mutual funds have gained 12% a year, on average, over the last three years, compared with a 49% average annual gain for domestic stoc k funds, according to Morningstar Inc. That performance edge is proving a big draw for American investors this y ear. Net US cash inflows to stock funds that invest overseas soared to a rec ord $797 billion in the first 10 months, compared with $476 billion fo r all of 2003, according to estimates from fund tracker Financial Resear ch Corp. A list of the 25 best-selling stock and bond mutual funds of 2004 include s five that primarily invest in foreign securities, Financial Research d ata show. By contrast, the 25 best-selling funds at this point last year all were domestic portfolios. For financial advisors, investors' growing interest in foreign securities is a welcome change from the 1990s, when many found it difficult to get clients to diversify away from the then-hot US market. "They would say, 'Tell me again why I should be in foreign stocks,' " sai d Craig T Cross, co-founder of investment advisory firm Halbert Hargrov e in Long Beach. Now, Cross said, "more and more clients" are asking about foreign investi ng. That could add to the downward pressure on the US currency's value agai nst the euro, the yen and other major currencies. By investing more in f oreign mutual funds, Americans in effect are selling dollars in favor of other currencies. On their own, those cash flows aren't big enough to make or break the buc k, experts say. Still, "they raise the hurdle for the dollar that much h igher," said Daniel Katzive, a currency strategist at brokerage firm UBS in Stamford, Conn. But a weaker dollar is exactly what many investors are betting on. As its value slides, foreign securities can automatically be worth more to US . And if foreign stock prices rally in their native currencies, that plus t he currency effect can provide hefty returns for American investors when the dollar is falling. This year, for example, the main blue-chip German stock index, the DAX, i s up a modest 55% in euro terms. The EuroPacific fund is the ninth-best-selling mutual fund this year. It took in a net $56 billion in new cash in the first 10 months, helping t o lift its assets to nearly $50 billion, according to Financial Research . By contrast, the $103-billion Vanguard 500 Index fund, which tracks the S &P 500, took in $3 billion in the first 10 months. Also popular this year are so-called exchange-traded funds that invest ab road. ETFs are portfolios of stocks, similar to conventional mutual fund s, but trade on the New York or American stock exchanges. The iShares MSCI-EAFE fund, which trades on the American Stock Exchange, tracks the broad-based Morgan Stanley Capital International index of Eur opean, Australasian and Far Eastern stocks. Assets in foreign-stock ETFs now total $304 billion, more than double th e $139 billion they held at the end of last year. Domestic-stock ETF as sets have risen 31% in the same period, to $1734 billion, according to the Investment Company Institute, the main trade group for mutual funds. Yet as interest in foreign shares booms, market professionals caution inv estors about being seduced by recent returns. "You're making a lot of bets when you buy a foreign stock fund," said Rus s Kinnel, director of fund analysis at Morningstar in Chicago. One obvious risk is that the dollar could suddenly strengthen. That would penalize American investors by shrinking the value of their foreign sha res when translated from weaker currencies to dollars. Many currency experts and investment strategists say the fundamental issu es weighing on the dollar including the nation's budget and trade defi cits, and the risk that they will get bigger before they get smaller m ake it more likely that the greenback is headed lower. "Our view is that the dollar will keep falling in 2005," said Rebecca Pat terson, a currency strategist at JP Morgan Chase & Co. Even so, market pros concede that predicting currency trends is a dicey b usiness. Political risks also are a factor in foreign investing, particularly in f unds that buy shares of companies in the developing world. For example, a political coup in one developing country could shake confidence in man y others. More worrisome, some experts say, is that a continuing decline in the dol lar against the euro and the yen could trigger recessions in Europe and Japan by depressing demand for their exports. A weaker dollar makes fore ign goods more expensive for US consumers, and US goods cheaper abro ad. If the net effect of a falling dollar was to cause recessions abroad, the declines in foreign stock markets might far exceed any benefit American s accrue from the currency factor. Kinnel and other advisors say the best reason to invest overseas is to pr ovide a portfolio with broader diversification, long term, than US sec urities alone can provide. In a mostly capitalist world, the US has no monopoly on growth businesses, analysts note. "Just going into a foreign fund because you think the dollar is going to go down for six months is a bad idea," Kinnel said. "You've got to go in for the right reason, which is diversification." Rick Keller, a principal at the Keller Group Investment Management in Irv ine, said he typically keeps about 20% of clients' total stock assets in vested in foreign funds. He said he had anticipated that the dollar woul d weaken in the last few years but that the slide had exceeded his expec tations. Nonetheless, Keller said he remained bullish on foreign markets, and beli eved he could justify raising some clients' foreign-stock assets to 30% of their total in equities. Considering the potential returns from stock price appreciation and the c urrency factor, "I'm probably still more optimistic on our foreign-stock allocation than on our US allocation," he said.
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