Investment Consult

Supercharge your portfolio with small foreign stocks

With technology seeping into every corner of the globe, little overseas firms have a better chance of striking it rich.

By Lewis J. Altfest, PhD, CFA, CFP

Out of sight, out of mind.

In the investment world, that cliche might well refer to small, foreign-based companies. Considering the spectacular performance of the major US stock markets in the 1990s, it's not surprising that investors virtually ignored all but the very biggest overseas firms. For that reason, though, many foreign small-caps are selling at reasonable prices, which makes this a particularly good time to shift some of your assets to them. Over the next several years, moreover, small foreign companies should offer the potential for outsized returns.

Like their US counterparts, foreign small-caps are flexible and can react faster than big companies to changes in the marketplace. And those changes will come, as many parts of the world that now lag behind the US begin using our technology and general know-how. For instance, markets in Asia and Latin America have rebounded from their deep declines of 1998. Growth in Europe has been solid, too.

Another reason to invest in small foreign companies applies to investing overseas in general: Foreign markets don't always move in sync with those in the US. Year to date, the Standard & Poor's 500 Stock Index is outperforming foreign- and world-stock mutual funds, but if history repeats itself I don't think it'll be long before foreign indexes begin to pull ahead of the S&P 500. (In general, world-stock funds hold a much higher percentage of US equities than do foreign-stock funds, which invest almost exclusively overseas.)

My advice regarding small-caps—especially foreign ones—is unwavering: Steer clear if you're nearing retirement and highly averse to risk. These investments are for younger, more aggressive folks who don't mind a little extra volatility in their portfolio or having to wait several years for good returns to materialize.

If foreign small-caps are for you, moreover, stick with mutual funds. Things can change rapidly in foreign markets, and there are simply too many complex factors—including local politics and currency fluctuations—for most individual investors to monitor. Funds are run by professional stock pickers who watch foreign markets closely and understand how they work, a claim few financial advisers and brokers can make.

The two no-load international funds I like best have most of their assets in companies based in industrialized countries—including Canada, England, Germany, Japan, and Sweden—plus a small amount in US firms. One is the $100 million Warburg Pincus International Small Company Fund (800-927-2874), which typically invests around two-thirds of its assets in small-caps, with a limit of 25 percent of assets in emerging markets. Although it has returned 38.7 percent over 12 months,* it's untested over long periods, having been in business only since May 1998. Nevertheless, Warburg Pincus has a solid management team well schooled in picking small foreign stocks, so I recommend this fund largely on that basis.

My second pick, Longleaf Partners International Fund (800-445-9469), is categorized as a mid-cap fund by Morningstar, the Chicago-based rating service. But because it has so many small-cap and micro-cap stocks in its portfolio, I consider it a small-cap fund. Like the Warburg Pincus fund, the Longleaf Partners one is only a couple of years old, albeit with triple the amount of assets under management. The fund has returned a solid 22.8 percent over the past 12 months, besting the S&P 500 by more than 9 percentage points. Its turnover is very low—especially for a fund that holds a lot of small stocks—which helps make it efficient from a tax standpoint.

Neither of the two funds is old enough to have earned Morningstar ratings, which apply to funds that are at least 3 years old. Both, though, seem well positioned to help you profit from growth overseas.

*Unless otherwise noted, all performance numbers are through Sept. 29.

The author, a fee-only financial planner, is president of L.J. Altfest & Co.(www.altfest.com), a financial and investment advisory firm in New York City. This column appears every other issue. If you have a comment, or a topic you'd like to see covered here, please submit it to Investment Consult, Medical Economics magazine, 5 Paragon Drive, Montvale, NJ 07645-1742. You may also send a fax to 201-722-2688 or e-mail to meinvestment@medec.com.

 

Lewis Altfest. Investment Consult: Supercharge your portfolio with small foreign stocks. Medical Economics 2000;22:29.