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68

Company

Asset Size

Average Discount 5-years

Adams Express

1099.4

-9.92

Gabelli Equity

104L1

-0.38

General American Investors

597.8

-9.58

Liberty All-Star Equity Fund

953.6

-1.08

Quest for Value Capital

890.9

-11.18

Royce Value Trust

440.9

-7.60

Salomon Brothers Fund

1588.4

-11.86

Tricontinental

2991.9

-13.70

Source: Prepared from Morningstar data.

Dont just jump in because the concept is exciting. Speculative activity in China, Hong Kong, and Mexico has cost investors billions of dollars in recent years. The idea that there are zillions of Chinese yearning to buy anything from an offshore company at fat profits is bunk. The people who buy this thesis remind me of the moonstruck EngUsh investors who lined up to purchase shares in the South Sea Company several centuries ago, convinced it owned mountains of gold and diamonds in the Indies.

Some of these markets certainly have potential, but if history is a guide, it takes years to develop large profits. When the realization dawned in the fall of 1997 that the payoff was further off than anticipated, and that a bumpy road lay ahead for a while, many of the Pacific Rim markets free-fell. Korea, Thailand, Malaysia, and many other formerly booming economies came within a hairs breadth of default debt and required well over $100 billion in bailouts by the International Monetary Fund and the banks of major industrial nations to save the day. As a result of this and similar crises, in mid-December of 1997 the Morgan Stanley index of emerging markets retumed only 27% for the most recent five years, 198% in the most recent ten. This compared to 151% and 425% respectively for the S&P 500. Thats right, in tiie past 10 years the "dull S&P" provided more than double the retum of the emerging market countries, without the currency and other risks inherent in these markets. Some bonus for investing abroad!

Does this sound spoilsport? Maybe you remember the red-hot German closed-end funds that sold at large premiums to asset value on the prospects of the reunification of Germany and the collapse of commu-

Table 9-4

Closed-End Investment Companies As of 12/31/96



nism. A number of the premiums on closed-end funds went to 50% or 100%. But German reunificadon proved much cosdier than expected and the premiums evaporated. You could have lost half or more of your capital purchasing these closed-end funds at their peak. The same was true in the mid 1990s in the Mexican and other Ladn American markets, as well as in other developing countries.

Lesson one, then, is that foreign investing is anything but a panacea. You have to apply the same contrarian principles you apply in U.S. markets. The 1997 debacle in the Pacific Rim markets is a classic example. Be extra careful to avoid the waves of speculation that often dominate in these areas. Even buying an index fund may not help much. In 1990 the Japanese market was in the stratosphere, trading at P/E multiples of 80 to 90 times eamings.

Sure, its high by our standards, we heard from the experts on Japanese stocks at the time, but the value is there. Japanese markets, like Japanese snow, are different.* Nippon Telephone, for example, traded at a P/E of 160 and had a market value many times larger than AT&T, although AT&T was several times its size. This one market made up fully 60% of the value of all stocks outside the U.S. before it collapsed in the early 1990s.

Another important consideration is that when you buy foreign companies, you are taking an exchange rate risk that can gready add to or detract from your total retum. In the years that the markets abroad outpaced those in the U.S., the gains were often more a consequence of a weak dollar than of strong markets overseas. Thus, when the dollar dropped in recent years, a good part of the fabulous retums on foreign portfolios-tmmpeted in many funds advertising-were not from the markets themselves but were there because these stocks were simply worth more with a cheaper U.S. dollar. More recendy, with the stronger dollar, the situation reversed. Behind much of the glamour of investing abroad, then, is simply speculation that foreign currencies will go up and the dollar down.

Remember, too, that foreign stocks looked strong in the early nineties because of the Japanese bubble. The fast-climbing Japanese market in tandem with the falling U.S. dollar made investing abroad appear to be a lay-up. When the Japanese market began to unravel in the early nineties, the foreign indexes fell apart.

Table 9-5 gives you the retums of global and foreign stock funds taken from Momingstar Mutual Funds. Glance at the third column,

* That Japanese snow was different was an argument Japanese ski manufacturers used against the import of foreign ski equipment for some time.



3 years

5 years

10 years

Average P/E

Average Market Capitalization*

Intemational Stock

Funds

6.1%

10.1%

9.6%

4,500

Standard & Poor 500

19.7%

15.2%

15.3%

5,850

* In $ millions.

Source: Prepared from Morningstar data.

which shows ten-year annualized returns. The average intemational fund does not approach the S&P 500, let alone the retums from contrarian strategies. Also, look at the average weighted P/E for foreign funds. It is 25, significantly higher than the P/Es we would buy following my strategies. Finally, look at the median market size these funds are buying. They are somewhat smaller than the stocks we would look at with contrarian strategies.

Over any reasonable period of time, then, investing abroad has not done any better-and oftentimes worse-than investing in the United States. Not only have the major domestic averages provided excellent retums overall, but you avoid the worries of currency fluctuations and also stay clear of thinly-traded speculative markets and geo-poUtical considerations.

Remember too, all foreign countries are not equally safe. I feel more comfortable investing in Westem Europe and Canada, or, if the P/Es come down, in Japan. I would not invest in South America or other regions with a record of debt defaults and restiiicturings. Our banks have taken a whipping in these countries, often losing 50 cents on the dollar on loans to their govemments. The underwriters of foreign securities assure us that things are different now. Maybe, but who can say that a govemment that has defaulted on debt wont change the rales again?

Having talked about the dangers involved in investing abroad, I hasten to add that there are opportunities in foreign stocks. One of die best for individual investors is to buy foreign securities traded in the U.S. markets. This avoids the high costs of overseas brokerage, safekeeping charges, and converting small amounts of foreign exchange at high spreads. American Depository Receipts (ADRs) represent a stated number of shares of a foreign stock traded in the U.S. Many of the larger

Table 9-5

Total Returns of International Stock Funds Versus the S&P 500 as of 12/31/96



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