(PUB) Investing 2015

risks inherent in investing in our U.S. markets, there are two additional areas of risk that must be considered. As I noted before, the first is cur- rency risk. Unlike owning U.S. funds or ETFs, when you buy a fund or ETF investing in overseas markets, you own stocks that are valued in their local cur- rency, be it the Japanese yen, the euro, or the Brazilian real. The movement of the U.S. dollar against these curren- cies can enhance, or detract from, your returns in foreign markets. A falling dollar makes shares in foreign curren- cies worth more; a rising dollar makes them worth less. I don’t believe that it makes sense to try to actively manage the currency risk in our portfolios—the managers of the foreign funds we use may be doing so themselves. That said, currency market considerations and what I know and hear from our portfolio managers can, on the periphery, inform my decisions about how much money to allocate overseas. Another risk that I haven’t men- tioned until now is political risk, and we’ve seen it in spades in Greece lately. When investing in a foreign stock fund, you are not only making a wager on the prospects of a set of companies, you are also making an investment in the political and economic stability of the countries those stocks are traded in. Until recently, this risk was the domain of emerging market economies. Unsustainable levels of debt, threats of default and currency devaluation, rising interest rates, bank runs, failed elec- tions—these were supposed to relate to developing countries struggling to find their place in a global economy, not the long-standing, developed European economies of Greece, Portugal or Spain, for instance. I take some comfort in the fact that the managers at International Growth, for instance, are boots-on- the-ground knowledgeable about these risks and are investing your money, my money, and their own in a fashion that takes these considerations into account. So given the rewards and the risks, how should you and I incorporate for- eign stocks into our portfolios? As discussed above, I don’t agree with the no-foreign-fund camp or the

for the past five years but has generally trended higher. This has been a head- wind for U.S. investors, because as the dollar rises, profits earned on stocks in foreign currencies are translated back into fewer dollars. By contrast, a weak dollar gives U.S. investors a tailwind when investing overseas. But the dollar won’t just keep rising and foreign cur- rencies won’t just keep falling. When the trend reverses, we’ll have a nice tailwind pushing returns higher. Time in the Markets So, let’s get back to the concern mentioned at the outset: Is now a good time to be invested in foreign stock markets? You could have asked this a year ago or five years ago. My answer wouldn’t have changed: Yes, absolutely. The headlines are grim. Europe is in rough shape. If you are looking for a solution to the problems in the euro zone, well, it is above my pay grade—if there even is a solution. At this point, it appears that the cycle of crisis, politi- cal chicken and Band-Aid bailouts will continue. Greece’s experience may be the latest and may cool anti-austerity parties in other countries given the hor- rendous conditions that have developed in the Greek economy. But the worries and uncertainties aren’t over for the euro zone. China, as I’ve been reporting to you in the newsletter and numerous recent Hotlines , has also been contributing its share of negative headlines, and the recent report of 7% growth in the second quarter just seems all too per- fect to be true. Fumbles on the policy front, whether related to economic poli- cies or investment and market policies like those that spurred the tremendous volatility in mainland markets, sow further doubts and uncertainties about this global giant. Yet, you know that old saw about markets climbing walls of worry. With worry aplenty, European Index is up 7.6% this year; Pacific Index , on the back of a big rebound in Japan, is up 8.1%; and World ex-U.S. SmallCap Index is up 4.5%. Contrast that with Total Stock Market Index’s 3.5% gain.

Diversification Still Alive andWell Jack Bogle’s antipathy to investing overseas notwithstanding, there remains a strong diversification benefit in own- ing foreign company stock. Yes, there are times when correlations between markets have been high, meaning the diversification benefit was low, but that isn’t always the case. Correlation is a measure of how synchronized two markets are. If the U.S. market and international markets were in complete synchronicity, they would have a correlation of 1.00, which implies they move 100% in lockstep. Over the past several years, the cor- relation between U.S. and foreign mar- kets have moved closer to 100% as the global economy has become more intertwined. Yet, as you can see in the graph below, they’ve never been perfectly correlated, and recently have fallen much further out of sync. A higher correlation in and of itself is not a reason to avoid foreign stocks. First off, the argument could just as eas- ily be flipped around: Given the higher correlation between U.S. and foreign stocks, wouldn’t I do just as well put- ting all of my money in foreign stocks? Maybe, but remember that just because markets are correlated doesn’t mean they are earning identical returns. And falling correlations, as you can see in the graph, could suggest that one market is gaining while another is dropping. Added Risks I would be remiss if I didn’t discuss something I mentioned above. While investing overseas assumes the same

U.S. and Foreign Stock CorrelationsChangeOver Time

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

3-yr. 5-yr. 10-yr.

6/73

6/76

6/79

6/82

6/85

6/88

6/91

6/94

6/97

6/00

6/03

6/06

6/09

6/12

6/15

6 • Fund Family Shareholder Association

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