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How to Truly Globalize Your Investment Portfolio

Stock-Markets / Investing Sep 17, 2007 - 12:53 AM GMT

By: Peter_Schiff


Americans may be known for their appreciation of world cuisines … but when it comes to investing, they generally stick with homegrown meat and potatoes.

That's too bad. Reason: As global economic imbalances finally right themselves, the American-only investors may be forced to start an unwanted crash diet.

As a Money and Markets reader, you're already aware of just how important it is to diversify your portfolio into foreign markets. You know that many emerging economies are expanding more rapidly, and you know that many foreign investments are vastly outperforming those here in the U.S.

But even if you've already got a stake in foreign markets, I'd like to tell you  …

Why You May Not Have Enough Truly International Investments

In the last few years, many U.S. investors have begun pouring money into global mutual funds, and they think they're getting great diversification.

However, many of the funds receiving the biggest inflows are about as authentically foreign as an Italian meal at the Olive Garden!

Here's why:

A lot of so-called "global" mutual funds have only 30% or 40% of their portfolios in foreign investments. Plus, many "emerging market" funds are heavily concentrated in mega-cap multinational companies that have huge U.S. businesses.

So these funds could suffer grievously when the U.S. economy sputters.

I'd like to take this a step further …

The typical U.S. investor considers foreign stocks and bonds to be extremely risky. So they allocate perhaps 5% or 10% of their holdings to international investments. In contrast, my colleagues and I believe the vast majority of investment risks are currently found in the U.S.

As a result, we recommend investors allocate at least 90% of their portfolios to non-dollar-denominated assets!

If you've been steeped in the rhetoric of Washington and Wall Street, that might sound extreme. But when you consider the current realities of the global economy, then I think you'll agree that our suggested approach is not at all risky, extreme, or as some would even argue, unpatriotic.

The Typical Foreign Stock Has Better Fundamentals, a Superior Yield, and a Lower Valuation than its Domestic Counterpart. Plus It Protects You Against a Declining Dollar.

We believe that the growing imbalances in the U.S. … its twin budget and current account deficits … its lack of domestic savings … and the erosion of its industrial base … have now reached a tipping point.

In our view, the dollar will have to decline substantially in value, perhaps as much as 50% or 75%. The principal factor that has prevented this from happening already is the unprecedented currency intervention of foreign central banks.

When this crutch is removed, and one day it will be, the dollar will fall hard. We do not celebrate this trend, but we do recognize it as an intractable force.

Some assume that a declining dollar is only a problem for those Americans who vacation abroad. What they don't realize is that a weakening greenback will also raise the cost of living right here in the U.S.

A falling dollar will not only limit the amount of goods flowing into the U.S., but also increase the share of U.S.-produced goods and services flowing overseas (as foreigners outbid Americans). The drop in supply means that prices will rise in real terms.

Buying foreign shares can help you prepare for that scenario, because you'll be setting yourself up for higher current income. Moreover, we believe this rise in income will occur precisely at a time when income from other sources, such as wages, stock price appreciation, and home equity extractions becomes increasingly hard to come by.

In short, we think a non-dollar-denominated investment portfolio will be the deciding factor in maintaining your current lifestyle.

We are not alone in our view that the greenback will fall, either. Former Fed Chairman Paul Volker, PIMCO Bond specialist Bill Gross, and legendary investor Warren Buffett have all sounded the same warning.

In fact, Buffett is positioning his own portfolio for that day. His holding firm, Berkshire Hathaway, recently paid $4 billion to purchase Israeli metalworking firm Iscar. Mr. Buffet expressly stated that he made the purchase because Iscar had a low valuation, generous cash flow, and generated almost all of its income from non-dollar sources!

So, how can you practice what Mr. Buffett preaches?

Although Many U.S. Brokers Still Make It Difficult, It's Never Been Easier to Buy Foreign Stocks and Bonds Directly

When asked about foreign exchanges, most American stock brokers will offer guarded appreciation while warning of loose financial controls and political, economic, and currency risks.

And even if your broker does offer access to foreign stocks, it's likely that they trade through domestic market makers. Typically, these middle men pocket the difference between the bid and offer prices on the thinly-traded U.S. over-the-counter markets.

Sometimes the spreads are really wide — as much as 10%! In most cases, investors don't even realize just how much of their money winds up in the pocket of market makers.

To avoid these extra costs, seek brokers that have relationships with on-the-ground traders in Sydney, Auckland, Toronto, Singapore, Hong Kong, Tokyo, London, and more.

By executing orders directly on foreign exchanges, they can cut out the market maker, and pass the savings on to the customers. Sure, they charge a trading commission, but the net charge is substantially less than going through a market maker.

The advantage: You'll be able to buy the kinds of foreign stocks that aren't typically included in global mutual funds or traded on U.S. exchanges as American Depositary Receipts (ADRs).

What to buy? At my firm, we believe that a conservative portfolio should be dominated by proven companies generating superior income for shareholders.

And right now, we think those investments are foreign companies that have no listing on U.S. exchanges, and are not included in U.S.-managed mutual funds. To name just a few categories:

  • Canadian energy trusts,
  • European Commercial REITs,
  • Australian Mining Firms,
  • Chinese utilities, and
  • Korean steel manufactures.

These are the sectors with companies that tend to trade at lower multiples — and offer much higher dividend yields — than their better-known rivals.

Reason: Their share prices have not been bid up by throngs of U.S. investors … YET!

By Peter Schiff
Euro Pacific Capital

Peter Schiff is President of Euro Pacific Capital , a stock brokerage firm specialized in serving investors interested in foreign securities. He is author of the bestselling book Crash Proof and appears frequently on CNN, CNBC, Fox News and many other media . To receive a free copy of his new Special Report, The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities, click here .

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