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Should You Reconsider World-Stock Funds?

This long-neglected type of mutual fund is worth another look.

Kai Wiecking, 06/06/2006

With the recent years of weakness in the U.S. dollar, paired with strong outperformance of most international markets and the fact that global market leaders across many industries now hail from abroad, it's clear why many advisors and investors alike are beginning to recognize that even the conventional 20% allocation to international equities may be too low.

In addition to revisiting the appropriate foreign allocation, investors and advisors might also do well to revisit how they obtain exposure to foreign stocks. Often, pure foreign-stock funds have been the choice over world-stock offerings, which invest in both foreign and U.S. stocks. Although the 112 funds in Morningstar's world-stock group have seen significant inflows lately, and their total assets now amount to $262 billion, that figure is dwarfed by the $632 billion amassed by the 410 funds grouped in the various foreign-stock categories.

Investors and advisors have long contended that world-stock funds make it harder to control a portfolio's overall exposure to foreign securities, and these funds may also create overlap issues with an investor's domestic holdings. In addition, the world-stock group has had more than its fair share of lackluster funds, with many fund shops merely soldering together a mediocre domestic fund with an equally underwhelming foreign offering.

Yet investors should reconsider world-stock funds, in part because they make good investment sense and in part because some of the world's top money managers take a global view of investing.

Many investors have a hard time fitting world-stock funds into their portfolios because they don't want to create too much overlap with their existing domestic-stock funds. (The typical world-stock fund currently allocates 42% of its portfolio to U.S. equities.) But the overlap issue isn't confined to world-stock funds. For example, 79 out of 607 funds in Morningstar's domestic large-blend category have international exposure of 20% or more. Many domestic-stock fund managers tell us that they're increasingly finding better opportunities overseas when searching out the most promising stock in a particular industry.

That raises the decisive question: Why should managers artificially restrict themselves to only picking from a regionally defined pool of stocks, whether it's the U.S. or the rest of the world? Many, if not most, fund shops have organized their research analysts into global sector teams. These analysts' "best ideas" are sometimes U.S. stocks and sometimes foreign firms. But the fund managers they supply can often buy only the second- or third-best idea because of geographic restrictions. Wouldn't it be more logical to pool their best global ideas in one portfolio?

Besides, when looking at large industry leaders these days, what's domestic and what's foreign anyway? Is Coca-Cola KO, which derives more than 70% of its earnings overseas, more American than British pharma giant GlaxoSmithKline GSK, which makes much more money in the U.S. than in the U.K. or anywhere else?PAGEBREAK

We're not suggesting that experienced investors dump all their existing stock funds and replace them with a world-stock offering. But we think there are several excellent options available in this group, and they make perfect sense for a beginning investor or someone with modest means who may not meet the minimum investment requirements for several funds at once. World-stock funds can also be a sensible choice for savings plans for young children or grandchildren, who will grow up taking globalization for granted.

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