How global should you go?

December 15, 2010: 5:00 AM ET

Most investors still don't have enough international stocks - especially those from emerging markets - in their portfolios.

By Mina Kimes, writer

When it comes to investing, people tend to prefer home cooking. For decades Americans gorged on U.S. stocks and barely touched foreign ones. There was good reason for that -- U.S. equities were, until recently, more widely traded and less volatile than their international counterparts -- but globalization and the continued downturn at home have given investors more reason to look outside the U.S. for growth.

Fund managers have responded: 30% of U.S. stock-fund assets are now invested abroad, according to a recent Vanguard report. That's roughly double the figure a decade ago.

That still isn't enough, according to some money managers. Consider the composition of the global market: The MSCI All Country World index, which holds market-capitalization-weighted stakes in indexes across the globe, now has 60% of its portfolio in non-U.S. stocks. The average world allocation mutual fund, according to Morningstar, keeps 50% of its equities investments overseas. John Calamos, CEO of Calamos Investments, thinks the fifty-fifty breakdown makes sense. "One of the things we've been telling investors is that they need to think more globally than before," he says.

Moreover, money managers say that investors should put as much as 15% of their portfolio in emerging-markets equities; the average allocation is 6%, according to Vanguard. "Although [they're] fashionable, I still believe the typical investor doesn't give the appropriate prominence to emerging markets," says Jeff Knight, head of global asset allocation at Putnam Investments. Although Knight is bullish on emerging markets, he also warns that they are volatile and could reverse course if investors flee when developed markets recover.

Despite being scaldingly hot in 2009, emerging-markets stocks are still cheaper than those in developed countries. They're trading at about 15 times normalized profits, compared with 19 for the U.S. and 17 for Europe, according to Ben Inker, head of asset allocation at GMO. China continues to draw huge amounts of money, but Inker prefers less frothy markets like South Korea and Russia. "We think [China] has probably got a real estate bubble," he says.

Emerging markets also offer diversification, says Wells Fargo chief portfolio strategist Brian Jacobsen. Meanwhile studies show that, as the global economy grows more interconnected, equity returns in the U.S., Europe, and Japan are tracking one another more closely. As a result, "the whole country-diversification thing doesn't mean what it used to mean," says Jacobsen.

That said, it's not clear that the correlation trend among developed markets will continue. Most fund managers still recommend spreading investments around the globe to take advantage of the significant opportunities abroad.

Many managers these days seek out the best of both worlds: stable, established multinationals with extensive sales in emerging markets. "There's often too much focus on where the headquarters of companies are rather than where their revenue comes from," says Calamos. The companies in the S&P 500, for example, together derive about 50% of their revenue from abroad, with about a third of that coming from emerging markets. And a recent study from Birinyi Associates shows that the S&P 100 stocks that garner at least 60% of their revenue from overseas are up 18% so far this year, vs. 7% for the overall index.

Such stocks capture international revenues -- but not the full stock market performance of those countries. The S&P 500 has been globalized for years, but it has still underperformed the MSCI Emerging Markets index by more than 10% annually over the past decade. Home cooking will always be great -- but there's ever more reason to add some variety to your portfolio.

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