More mutual fund groups are launching asset-allocation funds with greater overseas diversification. However, unlike global funds that purchase foreign stocks worldwide, the new generation of products are funds-of-funds.

A number of investment companies, including American Century, MFS Investments and HighMark Funds, recently launched asset-allocation funds-of-funds specifically to help investors do a better job of diversifying their assets, and these funds have noticeably significant overseas weightings. Although one-third of all mutual fund shareholders invest in foreign stock funds, according to the Investment Company Institute, foreign fund holdings represent only about 5% of mutual fund shareholder assets.

Mirroring U.S. Diversification

Many money managers make a point to diversify their clients' money in United States and foreign stocks, bonds and cash, as well as real estate and precious metals as a hedge against inflation. They also split their clients' assets by market capitalization and investment style. As a result, portfolios typically own large company, mid-size company and small company domestic stock funds. On the international side, they typically invest in large company foreign stock funds.

However, in the quest for diversification, one foreign stock fund does not cut the mustard. Instead, firms are spreading the risk among a variety of international funds.

American Century of Kansas City, Kan., has eyed the overseas markets for better risk management. Its new One Choice Portfolios offer five risked-based funds-of-funds that range from very conservative to very aggressive. American Century uses a strategic asset-allocation model to split investments based on expected rates of return and other factors, including fundamentals, earnings and trends.

Gina Sanchez, co-manager of the One Choice Portfolios, said that international weightings depend on the type of portfolio. The most aggressive portfolio can have 30% of assets in the fund group's overseas funds. American Century uses its International Growth and Emerging Markets Fund as its foreign component. The fund represents large-capitalization companies with fast-growing earnings. The Emerging Markets Fund is a multi-capitalization fund, providing style diversification.

"Overseas style diversification will help improve the risk-return of a portfolio," Sanchez said. "With five available risk levels to choose from, investors can easily select the portfolio that best aligns their specific risk-reward tolerance," Sanchez said.

Currently, the very aggressive portfolio has 16% of its assets in the International Growth fund and 8% in the Emerging Markets fund.

MFS of Boston is also focusing on greater overseas diversification by investing in a variety of international funds. In fact, MFS recently conducted a risk-return study on overseas investments and found that investors must diversify their foreign holdings among a variety of investment styles to get the best returns with the least amount of risk. An international portfolio owning a mix of large, mid-size and small company foreign stocks based on growth and value was one-third less risky that the MSCI EAFE index, according to MFS.

"International growth and value, small and large capitalization and emerging market stocks all have different correlations to one another and the U.S. markets," said Robert J. Manning, chief investment officer at MFS. "Investors diversify their domestic equity portfolios by investment style and market capitalizations. They don't view international investing the same way," but they should, he said.

Besides offering investors diversification through an international fund-of-fund, Manning also noted that MFS benefits from such an approach because it helps retain assets with the company.

The MFS International Diversification Fund puts 30% of the fund's assets in the MFS Research International Fund as a core holding that tracks the EAFE index, another 25% in the MFS International Growth Fund, 25% in the MFS International Value Fund, 10% in the MFS International Discovery Fund and 10% in the MFS Emerging Markets Fund. Back-tested research, Manning said, shows this asset mix has consistently delivered the best return per unit of risk over the long term.

HighMark of Boston entered the fray in October with three asset-allocation portfolios aimed at making it easier for financial advisers to diversify client assets. The portfolios are the Income Plus Allocation, the Growth and Income Allocation and the Capital Growth Allocation funds.

HighMark uses a proprietary dual alpha methodology that evaluates which asset class will show high excess returns over risk-free rates, as well as other assets. Investors are placed in a combination of asset classes, including international stocks, to get the best returns with the least amount of risk.

"Financial advisers requested smarter tools to enable them to more effectively manage client assets, said Greg Knopf, managing director with HighMark. "Our ultimate goal is to build wealth for investors over time using the unique institutional investment process we have developed for our multi-asset separate account business."

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