International mutual funds performance and characteristics

International Mutual Funds

Mutual Funds, the dynamic market:

The business of mutual funds changes continuously and one of the things that is done is to replace the manager of the portfolio, or even change the investment strategy for the fund. If the fund has been badly affected, the practice is to stop buying the risky growth stocks and instead buy the slower industrial and consumer stocks. This is the situation now at many growth funds in the United States which have come down by about 40% during the last two years. Yet the changes often do not lead to the results that are expected, and the changes that may have been correct to take up a couple of years ago may lead to a lot of damages now, after the market has already gone through a decline.

The type of stocks that are not in favor at certain times may again come back into favor, and then the change of style may harm the fund. This is what happened at a number of value funds when the market was seeing large rises from the growth funds. One of such funds was the $1 billion Safeco Equity fund, which was going below the Standard & Poor 500-stock index for a straight period of three years in the end 1990s. Then the management decided to boost up the results of the fund by getting into growth stocks in 1999, but these stocks also reached there peak a couple of months later. This made the fund turn out its worst result with a growth of 6% in 2000. 1

1. Geoffrey, Smith. When Your Fund Switches Tracks. Business Week Investor. March 4, 2002. Accessed 21 May, 2004. Available at http://www.businessweek.com/magazine/content/02_09/b3772112.htm

What is a mutual fund?

The aim of any mutual fund is to pool in the money from different investors and put it in a position where it can be managed by professionals. It is the manager who makes the trades and realizes the gain or loss and collects the income in the form of dividend or interest. The gains or losses are then passed on to the individual investors. The operation of most funds are open-ended, and that means that the investment company is at liberty to issue new shares to investors, and also undertakes to buy back shares from investors who want to leave the fund. There are also close ended funs which issue a fixed number of shares, and only these can be bought or sold by the investors among themselves through a stock exchange. The person who has issued these closed funds is not responsible for redeeming them, so the trading of these has to be only through a broker.

There are also mutual funds which are targeted to a particular agency like high technology or utilities. These mutual funds are known as sector funds. There can also be investment in bonds called bond funs which are targeted to different types of bonds which have different levels of risk like high yield or junk bonds; or types of issuers like government agencies, corporations or municipalities; or based on the maturity duration like short-term or long-term. There are both and stock funds can be investing only in U.S. securities in which case they are domestic funds, both U.S. And foreign funds when they are called global fund, or mainly foreign funds and then they are called international funds. The status of mutual funds is like corporations under the U.S. law, but they are subject to different rules for accounting and tax. These corporations are not taxed on their income, as long as most of it is distributed out to their investors. Again the nature of the income is not changed while going through to the investors. The mutual funds distributing tax-free municipal bond income remain tax-free to the investors. Other distributions can be ordinary income or capital gains depending on the method of earning by the fund. 2

There are some advantages of mutual funds which lead the investors to invest through the. The first benefit is that the investments are made with the experience and skill of professional investment managers and they have more knowledge and information to take the decisions than ordinary investors. The other factor is that mutual funds hold diversified portfolios, and these reduce risks. This is also through holding different types of assets like bonds, equities and cash, which stops people from being in the wrong investment at the wrong time. The third benefit of a mutual fund is from the liquidity it provides, and this is through the facility of selling the mutual fund units on any day and receiving the current market value of the investments made. Another advantage is that the initial investment required for a mutual fund is quite low, and some of them can be started for as low as $500. For this amount of investment, the funds provide the investors with detailed reports and statements that make record-keeping simple. The performance of the fund can be checked almost daily by just going through the business pages of most newspapers. 3

2. Mutual fund. Accessed 21 May, 2004 Available at http://www.wordiq.com/definition/Mutual_fund

3. FAQ's on Mutual Fund Investing. Fremont Mutual Funds, Inc. 2004. Accessed 21 May, 2004 Available at http://www.gabelli.com/university/qa-mf.html

There are choices of thousands of mutual funds, and it is not easy to make a choice. Some of the mutual funds are tax-free and they are useful to the investors in the highest tax brackets. The duration of the investment should be for the period that one expects the money to be invested. Thus money market funds are for money that one may require immediately and money that will be needed after retirement about 30 years later should be in long-term investments like stock or bond funds. Some funds call themselves "balanced funds" and they are not a good investment, as one can make a personal choice of the mix, and here stock is aggressive and bond is conservative. One should also look at the expense ratio in the prospectus of the fund, and the cheapest funds are better. 4

These are more important in index funds which are supposed to match the market. The highest returns are often from sector funds, but in business it is a different sector that is on top every year, and that is why it is risky to have them as major parts of the portfolio. The profit distributions are made by funds towards the end of their year, and the investors will have to pay taxes on the earnings when they get the dividend, so it is better to invest after the dividend is made so that taxes will be lower. It is important to go through the prospectus as the money is being entrusted to fund managers, and all its performance should be checked to make a good choice. To reduce risk, the investment should be always in a mixture and this can be in the form of stocks, bonds and cash. Among the stocks, there should be some foreign stocks. 5

4. Mutual fund. Accessed 21 May, 2004 Available at http://www.wordiq.com/definition/Mutual_fund

5. Mutual fund. Accessed 21 May, 2004 Available at http://www.wordiq.com/definition/Mutual_fund

The choice of international funds:

The international funds have varying reasons for choosing different reasons and as an example let us the reasons given by one of the funds called the Matthews Asian funds given for the choice of Asia as an investment destination. They begin by saying that almost half of the people of the world live in Asia and it is one of the largest regions of the world. The production from Asia is about 24% of the world's economic output and about 17% of the total world market capitalization is in Asian stock exchanges. During the last twenty years the Asian region has been having a mean growth rate of 4.4% and that is a lot more than the world average of 3.3%. Compared to Asia, the growth of the United States and the European Union has been lower at 3.2% and 2.3%. This has made the region almost the same size of an economy as is the European Union. From 1960, it has been noted by the economists and analysts that the investments made in Asia have been sound. 6

There have been good liking for the high savings rates in the region, the attained levels of educational progress, and the continuous emphasis on hard work and enterprise. In spite of these strong fundamentals the region did not grow very fast as there were quite a few structural weaknesses, and this led to the recent financial crisis, and that led to the economic downturn. Asia's companies are supposed to be one of the reasons for investing in the region, and the area full of entrepreneurial innovation. The spirit of entrepreneurship had given rise to many competitive companies in the areas of technology, finance and retail consumption. 7

6. Asian Funds. PFPC Distributors, Inc. May 23, 2004. Accessed 21 May, 2004. Available at http://www.matthewsfunds.com/whyinvest.cfm

7. Asian Funds. PFPC Distributors, Inc. May 23, 2004. Accessed 21 May, 2004. Available at http://www.matthewsfunds.com/whyinvest.cfm

The description of the entrepreneurship of Asia is considerable, but there is no clear indication as to the proposed area of investment. The area has been talked about a good area, but there are no reasons given why it should be able to yield better results than an investment in United States.

Getting to some other investment experts, who have a clearer idea about the international market; let us first understand that the market has grown rapidly in the last decade. The available funds are of four types - international, global, regional and country. The funds which may be truly called international funds invest only in well-known markets outside the U.S. like Germany, France, Japan, Hong Kong and Australia. These are well diversified and widely held. The global funds contain mixtures of U.S. And international stocks and they continuously chase the best performing market, and as a result, they have many U.S. stocks and are often quite similar in performances to a U.S. fund. Usually, as high as 75% of their assets, are invested in U.S. corporations. The regional funds concentrate in geographic areas like Latin America, Pacific Rim and Europe. The concentration of these firms is in small countries and emerging markets.

There are also country funds which concentrate only on one country, and this may help investors through strong and emerging economies. These are risky as they concentrate only one market. International funds are useful when it is felt that the U.S. market is not doing so well. There is also the factor that emerging markets in the foreign countries are expected to perform better than the U.S. market, whereas, the higher return foreign markets maybe in the same state as the U.S. market and may not perform very differently. At the same time, there may be high fluctuations as they may suffer from political troubles, and the returns received from those countries may be lower if the value of their currency drops against the dollar. The other difficulty is in selling out the investments as they have lower volumes than the U.S. And this may lead to a situation where the best prices may not be received for the investments. There is also the question of dealing with a foreign market, and this may lead to higher operating expenses, transaction fees and sales costs, and these go out of the profits of the investors. Still, they provide diversification and probably are the best method for getting the recommended 20% of the investment in foreign shares. The effort should be made however, after the U.S. portfolio of the investor as stable. These international investments have to be kept in the long-term due to the risks that are involved. 8

The important aspect of international funds is that they give the small investors an opportunity to invest in shares all over the world, and that would be very difficult or expensive to buy on their own efforts. It also provides a good opportunity for diversification. But just putting down the money for the overseas fund does not ensure a suitable amount of diversity, and the important thing for the investor is to find out the type of stocks that the fund has. The stocks may be high speed growth technology stocks, or on small cap stocks or even usual blue chip multinational stocks. 9 The choice for an international fund has to be made in a manner similar to the choice of other mutual funds as described earlier. The process is to collect a lot of information and most of this is available in the prospectus of the fund. (Selecting a fund)

8. Stock quest. Accessed 21 May, 2004. Available at http://investsmart.coe.uga.edu/C001759/guide/mutual4.htm

9. Schurr, Stephen. International Funds. August 16, 2000. Accessed 21 May, 2004. Available at http://www.thestreet.com/basics/gettingstarted/995887.html

Look at the goals, stocks, previous performance, fees, etc. The ideal fund should have the characteristics of consistency, bearable risk, low expenses, manageable asset size, and tax efficiency. Consistency is the knowledge that the fund has regularly made profits in the past, as that is what you want it to do in the future. The investor should be able to bear the risk that is associated with the fund, and one should not get into a fund that is too risky for the person. This can be found by looking at the worst year for the fund in the last 10 years, and one should be willing to loose that much in a bad year. The other item to pay attention to is the fees and this normally ranges between 1.2% and 1.9%, and one should target funds which have small expense ratios. Some funds have doubled in size over one year or so, and one should not invest immediately in those funds, as this high growth can cause problems to the manager with extra cash, and make him get into hasty decisions on investment. 10

The last point is analyzed by selected magazines and newspapers for the high tax efficiency that is had by some funds. The final question is to ensure that the mutual fund meets the financial goals of the individual and has remained in the high performance group of its category for the last five years. 11 It is wrong to think that all international funds do well, and that the definition given earlier of international funds is strictly observed. One of the funds is called William Blair International Growth is a fund that lost some 14% in the previous year, and was still in the list of top 11% of international funds. This fund keeps going into markets like Indonesia and South Africa, where they have some 19% of the fund's assets.

10. Selecting a fund. Accessed 21 May, 2004. Available at http://investsmart.coe.uga.edu/C001759/guide/mutual9.htm

11. Selecting a fund. Accessed 21 May, 2004. Available at http://investsmart.coe.uga.edu/C001759/guide/mutual9.htm

In addition there have been investments in Taiwan Semiconductor Manufacturing and Samsung, with the expectation that the investment in consumer electronics would improve the business for both these companies. This was expected to benefit from the demand in U.S., and at the same time there are other companies like AXP International which are doing very badly. 12 There has been a lot of growth of new money moving into international and global mutual funds and the rise was as high as 45% during 1999 from the previous year. The flow was the highest during the last six months of the year, and even then the domestic market did not seem to be doing so well though there were a lot of companies which reached their peaks.

The mutual fund lobby comes out with a journal called the Investment Company Institute and that said that as much as $1.4 billion of new money went into the international mutual funds in August 199, and that figure has been continuously climbing from that time. In December 1999, the data is available that as much as $7.4 billion went into the international funds. That figure represents the entire growth for the full year of 1998. When compared to the money that is being invested into the domestic mutual funds, this money is still small, and even the record figure of December 1999, was still half of the total flow into the domestic market. The reason for the growth is probably that the countries which seem attractive to investors are now seeing a lot of positive growth, except probably Japan at that time. 13

12. The New Superstar Funds: International Funds. Accessed 21 May, 2004. Available at http://www.smartmoney.com/magportfolios/funds/picks/index.cfm?story=pickfour

13. Kurapka, David. Long-Term Gains Lie Ahead for International Fund Investors.

February 23, 2000. Accessed 21 May, 2004. Available at http://www.thestreet.com/int/tradewinds/888212.html

Even in Japan, the market was climbing, and the average index for the Nikkei had climbed by as much as 40%. There are a number of the international funds which are in the top 10 of the funds in United States. The stock funds of Japan are rated only second to Pacific/Asia without Japan. There are also funds for diversified markets and Latin America, which are doing well. Still the investor who is looking for a profit in the short-term should not be in international funds. The growth in the international market still looks to be very good and the reason seems to be the growth in technology and e-commerce. These two have already had a reasonable growth in United States, but they are still in the beginning stages in the rest of the world. That is true even for the developed countries of Japan and the European nations. The usage of these techniques there are still small when compared to U.S.. One simple way of thinking is to think of the rest of the world being in the state that U.S. was in around 1993, and thinking of the rest of the world being there today. 14

The fundamental reason for investing in international funds is that it provides a safety belt that the national market cannot provide. Looking at the American market, there was a wonderful run recently with growths up to 37.6% in 1995, 23% in 1996, and 33.4% in 1997, and up to 28.6% in 1998. If these returns as reflected in the S&P 500 index were compounded annually, then, every $100 invested in January 1995 would have nearly tripled to $290 by the end of four years. One can understand how good the return is when one understands that a return of twelve percent is considered good, which enables an investment to double in about six years. 15

14. Kurapka, David. Long-Term Gains Lie Ahead for International Fund Investors.

February 23, 2000. Accessed 21 May, 2004. Available at http://www.thestreet.com/int/tradewinds/888212.html

15. Merriman, Paul. International Stocks: Should You Still Own Them? 1999. Accessed 21 May, 2004. Available at http://www.fundadvice.com/FEhtml/InvestingBasics/9903/9903.html

If one could be sure that the S&P 500 Index would always be increasing at this high speed, then the only thing one needed to live comfortably was just to invest in U.S. stocks. The same situation existed in Japan about 10 years ago. Then only some careful investors would have though about investing in U.S. stocks, but the other stockholders would not have thought the move to be wise, as the local investors would have thought that there were enough opportunities for investing in Japan. Then the situation changed and the Japanese index started falling and dropped from a figure of 39,000 yen to 14,000 yen. Earlier the Japanese mutual fund industry was doing well, but slowly 90% of the assets that it had just disappeared, and the situation has changed dramatically now. The list of mutual funds brought out by Morningstar has a total of 33 stock funds from Japan, and there are only five of them who have the figures for annualized returns going back for ten years. In the whole lot, only one has been showing a positive return in the ten years, and that had an annual return of 0.79% a year. 16

The entire average annualized Japanese stock fund returns from 1989 to 1998 was only losses, one of 3.4%. This means that an investment of $100 was left as an investment of $70.98. Yet when the investment had taken place, the Japanese had felt that they will get a good return from the investment. The large Japanese company stocks had even fared worse during this period from 1989 to 1998 and the rate of loss was 6.3%, compounded. This means that $100 turns into $55.89. Thus one can never be sure of returns from any mutual fund investment. This is also the need for international investing, and then even if the mutual fund industry in U.S. is not doing so well, one can expect to get some returns from the other investments. 17

16. Merriman, Paul. International Stocks: Should You Still Own Them? 1999. Accessed 21 May, 2004. Available at http://www.fundadvice.com/FEhtml/InvestingBasics/9903/9903.html

17. Merriman, Paul. International Stocks: Should You Still Own Them? 1999. Accessed 21 May, 2004. Available at http://www.fundadvice.com/FEhtml/InvestingBasics/9903/9903.html

This can be seen in the international funds and they often give reports. The Fremont International Growth Fund has gained 1.27% in the first quarter of 2004 as per their report, though they are behind their benchmark of MSCI Europe Australia Far East Index which has gained 4.34%. The main reason for their growth was due to the growth of Japan which was expected to be around 2.6% during 2004. The growth in Europe was expected to be lower at around 2% as per the stance taken by the European Central bank. This was also weakened further by the terrorist attacks in Madrid. This has caused very little growth in Europe. Detailed information like this is also sent by international funds. 18

On the opposite side is the practice by which some operators are taking advantage of practices in the mutual fund industry. Today the stock markets all over the world are very volatile and well coordinated than in previous times. This has happened since the Asian economic crisis of 1997, followed by the collapse of the Internet in 2000 and the aftershocks that followed the events of September 11th. This has led to high volatility, and combined with the regular industry practice of allocating mutual funds being priced only once daily has allowed the arbitrageurs to get good profits at the expense of the long-term investors. The profits have been high, and to the extent of $4 billion a year. The markets know about this problem for twenty years, and have not taken any action. This happens because of the timing of pricing for the net asset values of the Mutual funds. This is calculated at the available most recent market data of 4 p.m. Eastern Time. 19

18. Portfolio Manager's Review. March 31, 2004. Accessed 21 May, 2004. Available at http://www.fremontfunds.com/funds/figfx/comment.html

19. Hamilton, Andrea. The Blind Spot in Mutual Fund Investing. August 2002. Accessed 21 May, 2004. Available at http://www.gsb.stanford.edu/news/research/finance_mutualfunds.shtml

But, the foreign stock prices and the corresponding values of the U.S. funds holding them keeps changing according to the market prices. Only the NAV has been fixed. This gives an window to profit by daily trading. The arbitrageurs are able to earn more than annual returns from 35 to 47% by taking advantage of the time zones to trade daily in and out of the international funds as the prices in the foreign countries increase or decrease according to the U.S. demand. This practice has gone on for 20 years and is known to the market, but no action has been taken by most of the funds to correct it. The Securities and Exchange Commission is also aware of the problem and has issued a letter also to the funds regarding the problem. They have not forced the funds to institute fair value, or even advise the dilution to the investors in the mutual funds over the long-term. 20