U.S. investors are putting more of their money in mutual funds that invest in foreign stocks, but not as much as some investment advisers would like.
Investors are wary of foreign stocks because international markets have lagged the United States, the advisers say.
In addition, those markets in recent years have performed more and more like the domestic market, undercutting the argument that foreign stocks truly help to diversify a portfolio.
"Over time, the foreign funds are becoming more correlated," said Stephen J. Lansing, a retirement plan consultant with Gariel, Roeder, Smith and Co., Orlando.
But like many of his counterparts across the industry, Mr. Lansing continues to tout international funds. He tells employers they should offer at least one on the menu of investment choices in defined contribution plans.
"We're advocates of international investing," Mr. Lansing said. "We go along with the conventional thinking, academic and otherwise, that largely for the purpose of diversification, international funds have a place."
That is a bit of a hard sell at the moment. The Morgan Stanley EAFE Index, representing 1,600 stocks in Europe, Asia, and the Far East, returned 18.23% last year. The S&P 500 index, meanwhile, gained 26.67%.
Donald L. Ross, chief investment officer of National City Investment Management Co., a subsidiary of Cleveland-based National City Corp., suggests a 20% weighting in international funds.
But it can be hard to convince clients to increase their overseas allocations at a time when many international stocks are doing poorly, he said.
"Most people aren't contrarians," Mr. Ross said. "They say, 'Why are you bothering me?'"
The case for international funds is a long-term one, he said.
"While the returns in the U.S. have outperformed the rest of the world, especially the developed world, that's just a creature of timing," he said. "You should have a higher expected return (in international funds) over a longer period of time."
Then there is the correlation issue. For the three years ended March 31, the performance of the EAFE Index and the S&P 500 has been pretty closely in synch.
This is measured on a scale of 0.33 to 1; anything less is considered not correlated. A perfect correlation is 1. Over the three years, the correlation was 0.73.
It is not as if investors are fleeing from foreign markets. To the contrary, they held $200.6 billion in international funds at yearend, according to CDA/Weisenberger.
That is 5.6% of the assets of mutual funds offered in the United States, up from 4.9% at the end of 1993 and 1.5% at the end of 1988.
"Certainly the move to international has continued to garner speed over this decade, even though the theoretical argument has not panned out," Mr. Ross said.
This may be a testament to advisers' persistence, because many investors left to their own devices are content to keep their money in U.S. funds.
Max W. Smith, president of the Center for Investment Management, a registered investment adviser in Surprise, Ariz., said new clients with no international investing experience were "fairly common," even though most of his clients are retired or nearing retirement.
"If they were doing it on their own, they typically don't (invest overseas)," Mr. Smith said.
The firm uses international equities as one of the core asset classes in its model portfolio, using well-known fund companies such as Janus, Putnam, and T. Rowe Price.
Diversification aside, some investors may seek out international funds in order to own stakes in companies like DaimlerChrysler AG.
The company's shares are otherwise available to Americans only through American depositary receipts, an instrument that cannot match the diversification provided by a fund, Mr. Lansing, the retirement plan consultant, noted.
International funds "give people the opportunity to invest in companies that are not available other than through some type of foreign investment," he said.
For investors who really want diversification and are comfortable with risk, there is always emerging-market debt.
"That gives you plenty of diversification and volatility," Mr. Ross said, adding that emerging-market debt does provide "a pretty nice coupon of income, assuming these people can still pay."
Mr. Smith said his clientele's conservative nature tends to keep them out of emerging markets. Investing abroad in anything but large-cap funds "takes us out of our comfort zone," Mr. Smith said. "Volatility is too light a word."