The Party's Over

Overseas markets rewarded U.S. investors with outsize gains over the past five years, buoyed by a weak dollar in many parts of the world. When the subprime mortgage crisis broke last summer, investors hoped the damage would stay relatively contained. Instead, the ripple effects from the homegrown credit crunch spread worldwide. The crisis deepened this year, claiming storied investment bank Bear Stearns as a victim, and fueling concerns of a global slowdown. Loose credit standards created a leverage bubble that burst with a vengeance. The U.S. economy has a hangover, and the world's reaching for an Alka Seltzer.

While the initial impact of the credit crunch hit fixed-income markets the hardest, the longer-term effects have extended into world equity markets in the form of a "substantial correction," says Uri Landesman, head of global growth for ING Investment Management. The subprime/housing crisis was the trigger that tipped the U.S. economy into a bear market, Landesman notes, and world markets will likely follow.

The global investing climate has become trickier in recent months, no doubt. Morningstar's U.S. broad market index was down 6.1% this year as of April 4, and the dollar-denominated MSCI AC World Index was down 6.3%. One reason for this slight U.S. outperformance may be that the market is giving the U.S. credit for being at least partway through the current crisis, whereas the extent of its global impact remains unclear, says George Greig, manager of the William Blair International Growth Fund. After all, the market hates uncertainty even more than it does bad news.

This less-than-rosy outlook is not to suggest that investors should redirect their global allocations stateside. In fact, with about 78% of the world's listed companies outside the U.S., ignoring international investments is like "going to a 10-aisle supermarket and leaving after two aisles," says Audrey Kaplan, co-manager of the Federated InterContinental Fund. How can you ensure your clients get a balanced helping of global investments, especially when the markets are testing their resolve? For starters, you can reinforce the importance of international holdings to a diversified portfolio.

Most advisors agree that at least 20% of individual portfolios should be allocated abroad, while many money managers argue that that portion should be closer to 50%. Whatever your clients' international allocation, you should prepare them for more moderate returns across their entire portfolio, money managers say. It also makes sense to revisit their international holdings—especially their positions in emerging markets—to see if they've outgrown their target allocations in the past few years of blockbuster growth, and rebalance if appropriate. Lastly, you can explore with them the good opportunities that remain. Here, some top investors share their best ideas.

Bargain Shopping

Money managers see value in parts of Europe and Japan, where equities are trading at steep discounts to their intrinsic value (a measure of the perceived value of the whole company versus its market cap). Japan, in particular, offers deep bargains for patient investors. The world's second largest economy has languished in a slump for nearly 20 years, and still holds out little hope of a quick recovery. Charles de Lardemelle, chief investment officer for New York City–based International Value Advisers, likes NTT DoCoMo, a wireless telecommunications provider trading at a 23.5% discount to intrinsic value that is available as an American Depository Receipt, and Astellas Pharma, a pharmaceutical company trading at a 40% discount to intrinsic value, by de Lardemelle's measure, that is available to U.S. investors only through mutual funds. Taizo Ishida, manager of the Matthews Japan Fund, says Japanese REITs offer exceptional value. There are about 40 listed J-REITs, which U.S. investors can access only through mutual funds that pay an average dividend yield of 5.7%, compared with 1.9% for Japanese companies overall, Ishida says. His J-REIT picks for Matthews Japan include Japan Logistics Fund, Tokyu, United Urban Investment Corp., Global One Investment Corp and Nomura Real Estate Office Fund.

Europe has become a more attractive place to invest over the past five years, as companies there have adopted more shareholder-friendly business practices, says Sarah H. Ketterer, portfolio manager and CEO of Causeway Capital Management in Los Angeles, a value investing shop. Ketterer says she's been trading up in quality recently, as some high-quality companies in the region have come down in price. One example is British Airways, a standout in a beleaguered industry that has a great corporate balance sheet.

The strong euro has contributed to some European companies' attractive valuations, as it has made their goods more expensive and hurt their ability to compete with the U.S., says David Herro, manager of the Oakmark International Fund. This is why long-term investors must be wary of any boost they've received from the slumping dollar: While it temporarily jazzes up the returns on their international portfolio, a weak dollar ultimately hurts the foreign companies they invest in, making them less competitive. When you buy a foreign company, you are in effect selling the dollar, Herro explains, since you hold a foreign currency. Yet the prevailing investing wisdom tells us to "buy low, sell high." So you shouldn't be selling the dollar right now, with the greenback hitting record lows against the euro. That's why Herro started hedging his currency exposure this year, using forward contracts, as the already dragging dollar dropped an additional 6% against the euro in the first quarter.