The New Global Investor
Ah, the New Economy: Goods, capital, technology, labor, and information are traversing the globe as never before. Investing across borders, too, is easier than ever--and this still-nascent, worldwide economic transformation is rewriting the traditional rules of global investing.
Gone are the days when an investor could simply layer a few foreign stocks or funds, chosen to represent major countries or regions of the world, onto a portfolio of U.S. equities. Today's globetrotting investor looks for companies that are worldwide industry leaders--wherever they're headquartered. She's just as willing to buy Germany's Siemens and Sweden's Ericsson as America's Motorola or Qualcomm. "The really interesting companies are world-class at what they do," says Greg Smith, chief investment strategist at Prudential Securities. "The fact that they are American or Scandinavian is a side issue."
The traditional global investor sought diversification, hoping that European shares, say, would take up the slack when U.S. markets slipped. But as companies go global and stock markets increasingly move in sync, picking stocks by country or region no longer offers that protection. Instead, investors must diversify across industries, especially in those sectors--telecommunications, technology, pharmaceuticals, energy--where globalization rules the day. "The world has changed, and the industry dimension matters more now than the country dimension," says Stefano Cavaglia, head of equity strategy at Brinson Partners.
XENOPHOBIA. Fortunately, investors have more choices than ever as they construct a global portfolio. Mutual-fund managers more and more are looking at investment research and stockpicking from a global perspective. Sector funds--mutual funds that specialize in technology, health care, and other major industry categories--span the globe. A relatively new type of security, the exchange-traded fund, is giving traditional country-specific closed-end funds a run for their money. Stockpickers can buy shares of more and more foreign corporations in the form of American depositary receipts (ADRs) sold on U.S. stock exchanges. The World Wide Web offers plenty of cyberspace portals for gathering information on investment prospects abroad.
Americans have always been xenophobic investors: Research indicates that you're more likely to buy stock in your own local telephone company than to invest in even another Baby Bell, let alone a European telecom. And in the last decade, U.S. investors have seen little to tempt them to cross borders. Why go abroad when the Standard & Poor's 500-stock index is posting average annual returns of 18%, vs. a mere 7% annual gain in the Morgan Stanley Capital International Europe Asia and Far East (EAFE) Index? Add on the risk of foreign blowups--remember the Mexican meltdown of 1994-95 and the Asian crisis of 1997-98?--and U.S. stocks seem especially comforting.
Yet investing internationally has paid off in other eras. The EAFE index posted 23% average annual returns from 1979 to 1989, outpacing the S&P 500's 17.6%. And global economic indicators point to greater opportunities for investing abroad. Global inflation is dormant, and growth remains strong: The Wall Street consensus forecast predicts 3.8% world growth this year and 3.2% in 2001.
Internal reforms in many countries promise to bolster growth. With the rise of international trade agreements, governments everywhere are opening their economies and deregulating industries. European integration has ignited a firestorm of mergers and acquisitions. China will benefit from joining the World Trade Organization, and much of developing Asia is racing to join the New Economy. Japan's economy is barely stirring, but its industrial giants remain among the most competitive companies in the world.
Multinational corporations everywhere are embracing U.S.-style restructuring and New Economy strategies. Mergers and acquisitions--all the rage in executive suites--are accelerating the trend toward global industry sectors. Consolidation within industries accounted for three-quarters of all cross-border mergers over the past two years, vs. half in the early 1990s, calculates Cavaglia of Brinson Partners. High-tech companies are especially global in their reach: 40% of Yahoo!'s customers are outside the U.S., while Finland's Nokia has a 37% share of the U.S. cellular market.
LINKED MARKETS. But these same trends are undermining the traditional rationale for investing overseas: country diversification. Thanks to the rise of the Internet and a borderless world economy, national markets are sliding closer together. The correlation between the S&P 500 and Morgan Stanley's EAFE index has risen from 25% in 1995 to 78% this year--meaning that Wall Street and foreign bourses are now three times more likely to move in lockstep, according to the mutual fund company Rowe-Price Fleming International. Economists William Goetzmann of Yale and Phillippe Jorion of the University of California at Irvine point out that only twice in history--during the gold-standard days of the late 1800s and in the Great Depression--have markets been tied so tightly.
The 24-hour electronic worldwide stock market is especially powerful for technology, media, telecommunications, pharmaceuticals, and other truly global businesses. When America's tech-laden Nasdaq composite index rallies, so do Europe's Euro-tech index, Japan's Jasdaq, and Korea's Kosdaq. And when Finnish wireless giant Nokia shocked investors with lower-than-expected earnings on July 27, skittish investors hammered tech stocks worldwide. "It is more of a global marketplace, and maybe one of the best examples is technology," says Nick Sargen, global market strategist for J.P. Morgan.
Investors can still reap the rewards of diversification--but doing so takes a smarter strategy. The first step is to divide up the equity share of your portfolio among industry sectors. If you're a typical investor with average risk tolerance, you should allocate a significant chunk of your stock dollars to technology, media, and telecom shares, which constitute some 40% of global equity market capitalization. Your global portfolio should also encompass financials, which make up 20% of the worldwide market and include such behemoths as Citigroup and Deutsche Bank. Cyclical services, like restaurants, account for another 10%; pharmaceuticals are 8%, basic materials, 5%, and so on.
BRIGHT PROSPECTS. This sectoral approach does not rule out investing in U.S. companies. But even in New Economy areas that American companies dominate, there are some bright prospects to be discovered abroad. European companies Schlumberger and Gemplus are the world's largest makers of smart cards. Micronas, a Swiss/German company, developed the popular MP3 Internet music technology. Japan's NTT DoCoMo has the world's largest Internet cellular-phone network. Says Vince Fioramonti, international portfolio manager at Aeltus Investment Management: "Investing internationally is a way of increasing your opportunity to invest with leading companies everywhere."
Even if you invest mainly by industry, you'll want to allocate funds to the pursuit of country diversification. Legal, regulatory, and political variations among countries still count: Just look at Japan's stalemated politics, which is prolonging a decade of stagnation, vs. Germany's tax-slashing policies, which are expected to boost the country's growth rate from less than 3% this year to 3.5% in 2001. "Specific country policies toward their currency and economies still have an impact," says Jeremy Siegel, finance professor at the Wharton School at the University of Pennsylvania.
To carry out your strategy, you can choose from among an array of tools. Mutual funds remain the most popular way to invest abroad, either by sector or by country or region. With funds, you get professional money managers, aided by equity analysts who specialize in understanding industries worldwide, to deal with unfamiliar markets and exotic locales. Global index funds are a relatively low-cost venue for investing abroad. The Vanguard Total International Stock Index invests in Europe, Asia, and emerging markets. The E*Trade Funds Global Titans Index Fund tracks the world's 50 biggest blue-chip firms, based on a Dow Jones index.
MORE FUND OPTIONS. The global marketplace is more open to stockpickers these days, too. Finland's Nokia and Japan's Honda Motors are among the hundreds of foreign companies whose shares trade as ADRs on U.S. exchanges.
Wall Street is excited about exchange-traded funds, mutual funds that trade continuously through the day. You can buy single-country ETFs for 20 countries, ranging from Taiwan to Mexico and Germany, and new ones are being created all the time. Unlike the closed-end mutual funds traditionally used to invest in single countries, an ETF almost always trades close to its value of its underlying assets. And an ETF charges lower fees, because it's based on a country's stock index and doesn't employ professional stockpickers.
A compelling combination of economic and financial factors suggests that investing abroad is a better long-term strategy than ever. Look at it this way: Three decades ago, stocks worldwide were worth nearly $1 trillion--and America's markets accounted for two-thirds of that value. Today, the U.S. is less than half of a $32 trillion global market. In a world economy that's ever more tightly linked, the investment strategy of choice is a global one.