There were few consolations for U.S. investors last year, but at least domestic markets outperformed their offshore counterparts. In 2008, international stock funds lost nearly 45%, on average, while domestic funds lost about 37%, according to Morningstar. In the diversified emerging-markets category, the average loss was more than 54%.

This year, international equities, led by China, are starting to turn around. But they still have a long way to go. In the first quarter of 2009, international stock funds were down 10% (domestic funds lost 9%), while emerging-markets funds lost 1.6%. "The decrease in aggregate demand affected all countries," says Michele Gambera, chief economist at Ibbotson Associates, a subsidiary of Morningstar. "The dollar has rallied, which hurt some foreign securities. Together, it's a double whammy for investors in international securities."

 

AFTER THE FALL

What lessons should investors learn from this foreign flop? "The dollar remains the hard currency," Gambera says. "Many people shied away from long-term Treasury bonds. They forgot they have been good diversifiers in down markets."

In 2008, Treasuries rose while just about everything else fell, including foreign securities. Does this mean that one of the most important benefits of international investing-non-correlation-is disappearing? "Unless you're clairvoyant, diversification is your first line of defense against volatility," he says. "What's more, the cost of diversification is lower these days, thanks to exchange-traded funds."

Until recently, foreign investments have offered another important benefit-higher returns than domestic investments. Even after last year, international stock funds had a slightly positive 10-year annualized return while domestic stock funds showed a loss. Through the end of March, emerging-markets funds returned 7.7% a year, on average, over the last 10 years, among the best records of any equity fund category.

 

SEEKING SAFETY

Where in the world can investors make money these days? "Asian markets were hit hard, and Europe has not been spared," says David Winters, manager of the Wintergreen Fund. "Some of the world's best companies are selling at depressed prices."

Nevertheless, savvy professionals seem to be emphasizing caution and are buying what's familiar and apparently safe. "Most diversified international equity managers are staying away from large commitments to small-caps and emerging markets," says Karin Anderson, an analyst with Morningstar. "They're investing in large caps, especially in names they already own."

Defensive investing is another global theme. "Among sectors, healthcare and consumer staples have been popular," Anderson says. Winters lists Nestlé among his favorites. "So far the firm has done well," he says. "Consumers are still eating chocolate, drinking coffee and feeding their pets. The company, which is in sterling financial condition, has a nice yield and a growing dividend."

 

VALUE PLAYS

More aggressive planners might consider foreign energy companies. When the global economy recovers and oil prices head north, a big part of the increased revenues will go to the bottom lines of firms with ample, accessible reserves.

"A lot of oil is in unfriendly places," Winters says. "In addition, some of the major oil companies may be running short of reserves, which are getting more expensive to find and extract."

If the big firms decide to add reserves through acquisitions, they may look favorably at companies with reserves in a friendly country like Canada. Winters suggests Canadian Natural Resources in particular. "It's undervalued after the collapse in oil prices," he says. "The company has an estimated 50 years of reserves. Its cost of producing oil is low, so the upside potential is excellent."

While exploring for beaten-down oil companies appeals to some asset managers, bottom fishing for financials seems to be less common. "That sector might be a couple of years away," says Tom Shrager, a managing director at Tweedy, Browne, an investment firm in New York.

Nevertheless, some managers are willing to test the waters. In his March 30 shareholder letter, veteran value investor Marty Whitman, manager of the Third Avenue Value Fund, said he was buying distressed notes issued by GMAC and MBIA. Cliff Remily, associate portfolio manager of Thornburg Investment Income Builder Fund, is bullish on the Henderson Group, an asset manager based in the United Kingdom. "There is inherent operating leverage in its business," he says. If investment markets recover, the company's costs will not increase as rapidly as its asset management and performance fees. "Henderson Group has a strong balance sheet and a well-covered 7.2% dividend," he adds.

 

THE DIVIDEND ADVANTAGE

Indeed, many international money managers favor firms with high, secure dividends and a history of dividend increases. "We look for companies that are growing dividends, and we're finding more opportunities overseas," Remily says. "Foreign companies generally have higher yields and more of a bias toward paying dividends than U.S. companies."

Various types of foreign stocks pay significant dividends, according to Remily. "In the United States, dividend-paying companies are usually utilities, banks or REITs. Overseas, you can get high-dividend yields from all sorts of firms, including technology and telecoms."

Remily mentions Telstra, an Australian phone company. The firm has a secure balance sheet and a well-covered 9% dividend. "Even if people lose their jobs, they're likely to keep their cell phone and Internet service," he says.

Remily is upbeat on the Australian market in general. "The Aussie dollar is strong, there's no mortgage mess and borrowing is uncommon," he says. "As of April 3, the average yield on Australian equities was around 8.6%, more than twice the yield on the S&P 500."

If the focus is on financially stable, dividend-paying companies, it follows that most foreign investment dollars are going to already emerged rather than emerging markets. "Internationally, we invest primarily in developed markets," Shrager says. "We're finding beaten-down companies around the world. In some cases, we're buying back companies we sold at a profit, not that long ago."