Foreign Stock Funds Overlooked in U.S.

Investors have shown a strong appetite for domestic stock mutual funds this year despite a rocky U.S. market.

Yet Americans’ appetite for foreign stock funds appears tepid--even as the performance of foreign funds trounces U.S. returns, thanks to big gains in many smaller overseas markets and the dollar’s slide against key currencies.

In April, domestic stock funds took in $11.1 billion in net new cash, boosting the year-to-date total to $62.4 billion, according to data reported Thursday by the Investment Company Institute, the funds’ chief trade group.

By contrast, international stock funds had a net cash inflow of $678million in April, bringing the year-to-date total to $4.4 billion, the institute said. Net cash flows measure new dollars invested minus redemptions.

The money going into foreign funds this year is 6.6% of the total stock fund inflow. That’s down sharply from 2000, when foreign funds took in 16.1% of all new dollars invested in stock funds. In the early 1990s, foreign funds grabbed as much as 38% of total inflows.

Small investors often are accused of chasing hot fund sectors, but that doesn’t seem to be true with foreign funds this year. Through last week, the average international stock fund was up 5.9% for the year, while the average U.S. stock fund was down 4.3%, according to fund tracker Morningstar Inc.

Some individual sectors within the foreign stock fund universe have been rocketing. The average Japanese fund was up 13.9% year-to-date through last week; the average emerging-markets fund was up 14.7%.

Though financial advisors say performance-chasing is one of the easiest ways to ruin a portfolio--because of the risk of buying a hot sector just as it peaks--some analysts say investors might be missing the boat by shunning foreign stock funds this year.

“U.S. market valuation is still quite high on the world scale,” said Don Cassidy, an analyst at fund data tracker Lipper Inc. in Denver. “Even without the portfolio-diversification argument, which people can and do disagree about, you can find cheaper companies elsewhere.”

Some advisors recommend keeping 5% to 15% of one’s total equity holdings in foreign stocks, as part of basic diversification.

Some foreign markets, particularly in Asia, have posted strong gains this year on expectations that their economies will rebound sharply as the global economy recovers. The South Korean market, for example, is up 18% this year.

Meanwhile, the dollar’s slide against the euro, the yen and other key currencies is boosting foreign stock returns for U.S. investors. As foreign currencies grow stronger, assets denominated in those currencies automatically are worth more when translated into dollars.

Though most European markets have fallen this year, the strong euro currency has cushioned losses for U.S. investors. The German market, for example, is down 7.7% in local currency terms, but in dollar terms it’s down 2.8%--a smaller decline than the 7.3% drop in the U.S. Standard & Poor’s 500 index.

Yet for many Americans, “There may be a fear of markets that are far away and perhaps hard to understand--and that fared worse than the U.S. in recent years,” Cassidy said. Indeed, foreign stock fund returns lagged behind the S&P; 500 in six of seven years between 1995 and 2001, souring many people on the idea of foreign diversification.

This year, more investors appear to be taking an interest in emerging-markets funds, which own stocks in markets such as Mexico, Thailand and South Africa. The sector makes up about 4% of total foreign fund assets but has accounted for 22% of foreign fund cash inflows this year, through April, according to ICI data.

Along with emerging-markets funds, some major international funds with solid long-term records are attracting plenty of cash this year. Best-selling funds include Artisan International, which took in a net $1.2 billion this year through April, and American Funds’ EuroPacific Growth, which took in $714 million, according to Boston-based consulting firm Financial Research Corp. Both funds are slightly in the black year-to-date.

Stock funds overall continue to attract new money, despite the struggling U.S. market, because investors continue to save regularly for retirement in 401(k)s and IRAs, analysts say. Also, more money has been flowing into small-stock funds and value-oriented funds, which have fared best this year.

Still, the total April stock fund inflow of $11.8 billion was down from $29.6 billion in March.

Bond mutual funds attracted more cash in April: Net inflows totaled $7.8 billion, up from $6.7 billion in March.

At fund giants Fidelity Investments and Vanguard Group, recent trends continued in May, spokesmen said, with net inflows for their stock and bond funds.