Where in the World Are Developed Markets?

By John Arnopp
Analyst, mPower

When you hear the terms "international" or "foreign" stocks, what do you think of? A large, established European pharmaceuticals company? Or a small, somewhat volatile third-world telecommunications concern?

Foreign stocks generally fall into two categories: "developed market" and "emerging market." Each presents its own opportunities and risks for your portfolio. We'll take a look at both in this two-part series, starting with developed markets this week.

Why even consider international investments?

Many of us, when presented with the idea that we should invest a portion of our long-term retirement money in international, foreign, or overseas stocks, respond with the question, "Why would I want to do that?"

In short, over half the world's equity investment opportunities lie outside the U.S. But while international stocks are "foreign" to us, the factors affecting them are largely the same as those affecting U.S. stocks: earnings, interest rates, and the outlook for inflation and the home economy. Still, international investing involves additional uncertainties that you wouldn't necessarily have to worry about with a U.S. stock, such as the country's political stability, or its financial reporting standards -- which might be less stringent than in the U.S. and currency/exchange rate risk.

Determining which foreign stocks are right for your portfolio

EAFE Countries (By Weighting) Japan United Kingdom Germany France Switzerland Netherlands Italy Spain Australia Sweden Hong Kong Finland Belgium Denmark Singapore Portugal Ireland Norway Austria New Zealand

Just as U.S. stocks can be divided up into asset classes, such as large-cap and small-cap, foreign stocks can de divided into developed markets and emerging markets. Developed markets are defined by the World Bank as countries with a minimum gross national product of about $10,000 per person. Their markets share certain characteristics, such as having been in operation a long time, having reached a certain size and stability, and having attained a degree of sophistication.

What countries are considered "developed"?

Most diversified international funds are benchmarked against the Morgan Stanley Capital International Europe, Australasia, Far East (MSCI EAFE, or just EAFE) index. The EAFE index is composed of 20 developed country markets. The weightings in the EAFE vary over time. For example, in the early 1990s when Japanese stocks were flying high, they accounted for over 60% of the EAFE's market capitalization. Early this year, Japan's weighting was about 23% of the EAFE, just slightly more than the U.K., but still on top.

Other funds may be benchmarked against more specific indices that better reflect the investment style of the particular fund. These funds may invest in specific regions, such as Europe, Japan, or Asia excluding Japan. They may also invest in global or foreign sectors such as communications or health care, or more generally, in specific themes, like growth or value stocks.

Deciding what type of fund to invest in

If you've decided to take the plunge and invest in an international fund (or are thinking about it), what exactly should you own? If you bought a diversified developed markets fund that benchmarks itself to the EAFE, you would own a diversified portfolio that looks quite different from a domestic large-cap portfolio such as the S&P 500 index. The S&P's largest sector weightings are in technology (20%), financials (16%), services (15%), and health (12%). The EAFE, by contrast, is much less tech heavy and more financials-oriented. Its top sectors are financials (26%), services (18%), industrial cyclicals (12%), and health (10%). While the S&P index has a mere 2% weighting in consumer durables, the EAFE has about 9%..

The individual companies that you are likely to see in a developed market mutual fund portfolio may or may not be familiar to you, but as large multinationals beef up operations through expansion and mergers, they will undoubtedly become household names. They include companies such as BP Amoco, Nippon Telegraph & Telephone, Glaxo Wellcome, Royal Dutch Petroleum, Toyota, Mannesmann, Nokia, Sony, DaimlerChrysler, Roche, and the list goes on. These large companies (as a group, they have a median market capitalization of $30 billion) are driving economies around the world the way domestic companies like Coca-Cola, General Electric, and Microsoft influence the global economy, and they should not be overlooked.

That all sounds great, you say, but what about the bottom line? Will international investing make you money? The answer is yes. The chart below illustrates the annual returns for the EAFE and the S&P 500 from 1974 through 1998.

There are two great things to note about this graph. First, domestic and international returns usually have an unrelated relationship. This means that while domestic funds may be performing poorly, international funds can make up some of the loss with superior returns, and vice-versa, leading to a more well-behaved portfolio. Second, over the indicated period, the average annual returns have been about the same. With average annual returns of 16% for the S&P 500 and 15% for the MSCI EAFE, you can have your (German) chocolate cake and eat it too!

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Where in the World Are Developed Markets?

By John Arnopp
Analyst, mPower

When you hear the terms "international" or "foreign" stocks, what do you think of? A large, established European pharmaceuticals company? Or a small, somewhat volatile third-world telecommunications concern?

Foreign stocks generally fall into two categories: "developed market" and "emerging market." Each presents its own opportunities and risks for your portfolio. We'll take a look at both in this two-part series, starting with developed markets this week.

Why even consider international investments?

Many of us, when presented with the idea that we should invest a portion of our long-term retirement money in international, foreign, or overseas stocks, respond with the question, "Why would I want to do that?"

In short, over half the world's equity investment opportunities lie outside the U.S. But while international stocks are "foreign" to us, the factors affecting them are largely the same as those affecting U.S. stocks: earnings, interest rates, and the outlook for inflation and the home economy. Still, international investing involves additional uncertainties that you wouldn't necessarily have to worry about with a U.S. stock, such as the country's political stability, or its financial reporting standards -- which might be less stringent than in the U.S. and currency/exchange rate risk.

Determining which foreign stocks are right for your portfolio

EAFE Countries (By Weighting) Japan United Kingdom Germany France Switzerland Netherlands Italy Spain Australia Sweden Hong Kong Finland Belgium Denmark Singapore Portugal Ireland Norway Austria New Zealand

Just as U.S. stocks can be divided up into asset classes, such as large-cap and small-cap, foreign stocks can de divided into developed markets and emerging markets. Developed markets are defined by the World Bank as countries with a minimum gross national product of about $10,000 per person. Their markets share certain characteristics, such as having been in operation a long time, having reached a certain size and stability, and having attained a degree of sophistication.

What countries are considered "developed"?

Most diversified international funds are benchmarked against the Morgan Stanley Capital International Europe, Australasia, Far East (MSCI EAFE, or just EAFE) index. The EAFE index is composed of 20 developed country markets. The weightings in the EAFE vary over time. For example, in the early 1990s when Japanese stocks were flying high, they accounted for over 60% of the EAFE's market capitalization. Early this year, Japan's weighting was about 23% of the EAFE, just slightly more than the U.K., but still on top.

Other funds may be benchmarked against more specific indices that better reflect the investment style of the particular fund. These funds may invest in specific regions, such as Europe, Japan, or Asia excluding Japan. They may also invest in global or foreign sectors such as communications or health care, or more generally, in specific themes, like growth or value stocks.

Deciding what type of fund to invest in

If you've decided to take the plunge and invest in an international fund (or are thinking about it), what exactly should you own? If you bought a diversified developed markets fund that benchmarks itself to the EAFE, you would own a diversified portfolio that looks quite different from a domestic large-cap portfolio such as the S&P 500 index. The S&P's largest sector weightings are in technology (20%), financials (16%), services (15%), and health (12%). The EAFE, by contrast, is much less tech heavy and more financials-oriented. Its top sectors are financials (26%), services (18%), industrial cyclicals (12%), and health (10%). While the S&P index has a mere 2% weighting in consumer durables, the EAFE has about 9%..

The individual companies that you are likely to see in a developed market mutual fund portfolio may or may not be familiar to you, but as large multinationals beef up operations through expansion and mergers, they will undoubtedly become household names. They include companies such as BP Amoco, Nippon Telegraph & Telephone, Glaxo Wellcome, Royal Dutch Petroleum, Toyota, Mannesmann, Nokia, Sony, DaimlerChrysler, Roche, and the list goes on. These large companies (as a group, they have a median market capitalization of $30 billion) are driving economies around the world the way domestic companies like Coca-Cola, General Electric, and Microsoft influence the global economy, and they should not be overlooked.

That all sounds great, you say, but what about the bottom line? Will international investing make you money? The answer is yes. The chart below illustrates the annual returns for the EAFE and the S&P 500 from 1974 through 1998.

There are two great things to note about this graph. First, domestic and international returns usually have an unrelated relationship. This means that while domestic funds may be performing poorly, international funds can make up some of the loss with superior returns, and vice-versa, leading to a more well-behaved portfolio. Second, over the indicated period, the average annual returns have been about the same. With average annual returns of 16% for the S&P 500 and 15% for the MSCI EAFE, you can have your (German) chocolate cake and eat it too!

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.