Where to invest overseas now

By Tim Middleton

The last month has been a stress test of global equity markets, and our own market has come off poorly.

The S&P 500 Index ($INX) fell 3.9% in the 30 days ending Nov. 20, while the main measure of foreign stocks fell just 2.7%. Vanguard Emerging Markets ETF (VWO, news, msgs), which tracks the most widely followed benchmark in that space, did even better, slipping just 0.2%.

American economic dominance appears to be waning in this young century. The U.S. share of global gross domestic product is just 29%, according to Morgan Stanley. Europe -- Great Britain and the euro zone -- is the same size, and emerging markets edge them both out, accounting for 31% of the total.

It's possible the United States is already slipping into recession; downturns are recognized only in retrospect. As The Economist noted recently, 95% of American economists polled in March 2001 said a recession was not likely, but it was already under way.

Overseas overweight

So the market's recent divergence could simply be acknowledging an economic reality that will start turning up in official statistics next year. As investors, however, we don't have to wait. In this decade we've been smart to diversify internationally. Now we need to shift even more of our dollars over there.

And the sweet spots of foreign investing now are growth stocks in developed markets and industrial stocks in emerging markets. I've identified three funds -- two mutual funds and one exchange-traded fund -- that I think are most likely to capture the fullest impact of these trends.

Harbor International Growth Fund (HIIGX) and Janus Overseas (JAOSX) are superbly managed mutual funds that are heavily committed to both trends. Vanguard FTSE All-World ex-US ETF (VEU, news, msgs) is the ETF which, unlike index funds that track Morgan Stanley's EAFE (Europe, Australasia, and Far East) Index, ignores neither emerging markets, which account for 20.5% of assets, nor Canada, which accounts for 5.4%.

If you don't own funds of this type, you are missing the boat. And you're missing it if you don't own enough of them. The classic asset-allocation model, which is heaviest on domestic stocks, is obsolete when the dollar is not sound. I'm migrating toward an outright majority of foreign equity holdings, with plenty of emerging markets. I think you'll benefit from doing likewise.

Safe Harbor

Harbor International Growth is down only 0.8% in the last month and ahead 18.6% this year, trouncing the EAFE index as well as domestic stocks.

Harbor is an economical family of funds that hires top-tier subadvisers. In this case, that is Marsico Capital Management and its outstanding foreign-stock portfolio manager, Jim Gendelman. Top holdings that have been runaway successes this year include Canada's Research In Motion (RIMM, news, msgs) and China's China Mobile (CHL, news, msgs) and CNOOC (CEO, news, msgs), an oil giant.

Gendelman owns a fairly concentrated portfolio of about 60 names, nearly all of them very-large-cap growth stocks, including Nestlé, the Swiss maker of food products. But he's been equally aggressive in loading up on stocks sensitive to the global commodity crunch, like Potash of Saskatchewan (POT, news, msgs). About 30% of assets are invested in the 10 largest holdings.

The Harbor fund is a cheaper clone of Marsico International Opportunities (MIOFX). The brand-name fund charges 1.44% in annual expenses; Harbor charges 1.37%.

Too good?

Janus Overseas is even more economical (0.91%) and has an even better record than Harbor. It's down just 0.5% in the last month and ahead a resounding 25.1% this year. Over the last decade this fund has delivered returns that rank it among the top 5% of foreign large-cap funds.

Manager Brent A. Lynn co-managed this fund in the early 2000s with the legendary Helen Young Hayes, who departed in 2003 after three consecutive years of double-digit losses. Since then annual returns have been positive in the double digits; last year it roared ahead 46.3%.

The fund's very success is what worries Morningstar. "Its large stake in emerging markets and subsequent low stake in developed foreign markets keep it from being a suitable core offering," opines analyst Karen Dolan.

This fund's holdings on average are only one-third the size of the Harbor fund, and many of them are concentrated in the most volatile sectors, like technology. The fund is relatively light on energy and industrial materials.

But Lynn is a good stock-picker; turnover is about 40% less than at Harbor. And he's certainly bold. The top five holdings are Hong Kong's Li & Fung (LFUGF, news, msgs), India's Reliance Industries (RLNIY, news, msgs), South Korea's Samsung Electronics (SSNLF, news, msgs), Taiwan Semiconductor Manufacturing (TSM, news, msgs) and Sharp (SHCAF, news, msgs).

Continued: Maintaining flexibility

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