Investors are piling into mutual funds that invest outside of the United States. The lure of Japan’s soaring market, Europe’s nascent economic recovery and the potential for stronger economic growth in developing economies have led investors to pour a net $91 billion into world stock mutual funds through the first eight months of the year. That’s nearly six times what they’ve put into domestic stock mutual funds, according to the most recent data from the Investment Company Institute.
It’s a continuation of a trend that’s been going for years, both by average investors and by mutual fund providers, in the search for a more diversified portfolio. Stocks from other countries can zig when U.S. markets zag, offering a smoother ride for investors. That’s why fund companies have bulked up on foreign stocks in their target-date retirement funds, which are built to take care of investment decisions for savers. The average target-date fund designed for those aiming to retire in 2040 had 36 percent of its stock portfolio in foreign companies at the end of 2012, up from 24 percent at the end of 2005, according to Morningstar.
The split in interest has become even more pronounced in recent weeks: Investors added a net $924 million to world stock funds during the two weeks ended Oct. 2. Over the same time, they turned their backs on domestic stock funds and pulled out a net $8 billion.
One attraction has been the bigger dividend yields that foreign stocks offer. Stocks from developed markets around the world carried a dividend yield of 3.1 percent at the end of September, according to the MSCI EAFE index.
Stocks across Europe and other countries are also trading at lower prices relative to their book values than their U.S. counterparts, says Bill Nasgovitz, one of the managers of the Heartland International Value fund (HINVX). That can provide investors with a stronger safety net in case volatility hits the market again.
Investing in international stock mutual funds carries risks, of which investors should be mindful. They include:
CURRENCY CHANGES: Swings in foreign currency values can hurt returns for investors after translating them back into dollars. Indonesia’s stock index is up 4 percent this year in terms of the Indonesian rupiah, for example. But in U.S. dollar terms, it has dropped nearly 13 percent.
VOLATILITY: Foreign stocks can have more severe swings than U.S. stocks, particularly those from less developed economies. Brazil’s Bovespa index plunged 11 percent in June amid worries about economic growth and protests in the streets, for example.
POLITICS: Companies in other countries may use different accounting standards than U.S. companies, and investors fear governments in some countries could expropriate private assets.
Fund managers closely follow elections and other political changes that could quickly affect investors. “You can have somebody win an election and create better or worse tax environments for dividends for these companies,” JPMorgan’s Camporeale says.