Foreign Stocks Down But Not Out
The European debt crisis and a strengthening U.S. dollar have weighed on foreign stock returns this year, and international stock funds have lost considerable ground relative to their domestic counterparts. Through May 11, the average foreign large-company blend fund was down 5.7%, while its U.S. counterpart was up 3.4%.
The pain is widespread. Among 32 Dow Jones country indexes, 20 are down in U.S.-dollar terms this year. Greece is the hardest hit, plunging 34%. The widely followed MSCI EAFE Index, which includes stocks from Europe, Australasia, and the Far East, holds only about one-quarter of one percent of its assets in Greece. The index’s largest bet is Japan (about 22% of assets), which has seen its Dow Jones index rally 3% this year. But the United Kingdom (20% of assets) is down 9%, while France (10%) is off 15% and Germany (8%) is down 12%.
While Europe’s sovereign debt woes have raised doubts regarding the region’s economic recovery, currency swings explain most of this year’s underperformance in foreign funds. The effect of fluctuating currencies on the EAFE Index. So far in 2010, the index is down 2.4% in local currencies. But converted to dollars, the index shows a loss of 8.4%.
Some funds hedge currency exposure to reduce the impact of exchange-rate fluctuations. When the dollar rises against foreign currencies, a hedged fund will have an edge. In most cases, foreign index funds are not hedged.
Disheartened investors should not disengage. A $1 trillion European financial bailout lifted stocks on May 10 amid hopes that the region’s debt problems will be resolved. Importantly, over the long haul, foreign funds can diversify portfolios and reduce risk without hindering performance.
The Forecasts’ recommended funds, including four top international picks, are listed below. One of our favorites — Vanguard Total International Stock Index ($14; VGTSX) — tracks a benchmark consisting of the MSCI EAFE Index and MSCI Emerging Markets Index. On March 31, portfolio weightings were: Europe (49% of assets), Asia/Pacific (26%), and emerging markets (24%). The fund is down 5.7% this year. Another attractive pick is Vanguard International Value ($28; VTRIX), which focuses on undervalued large-cap stocks. The fund, with a roughly 57% weighting in Europe, is down 7% this year.