Instant Portfolio Diversity: Buy International Stocks

IN 1993, Earl Zastro, a claims superintendent at State Farm Insurance Company in Tinley Park, Ill., realized he had only about 5 percent of his financial assets in international investments.

''I saw everyone making money from international stocks. So within a six-month period, I upped my portfolio to 30 percent [international],'' he says. ''And I started to make all these high rates of return,'' spurred by high economic growth rates abroad.

Last year, of course, many investors fled overseas markets -- as scores of stocks hit the skids in Mexico, Latin America, Hong Kong, and Eastern Europe. Even major markets, such as Britain and France, were down. Undaunted, Mr. Zastro continues to buy into international mutual funds, many of which post solid earnings gains. Zastro's portfolio is ''now around 35 percent international,'' he says.

Many financial planners suggest this is high, recommending rather 5 percent to 10 percent international. They also note that foreign investments are subject to sharp fluctuations in foreign-exchange rates, which can go against the investor.

''It's a difficult time for the [small] retail investor,'' says Mark Mobius, president of the Templeton Developing Markets Trust, and the Templeton Emerging Markets Fund. Both are part of the Franklin Templeton Group. ''Many investors were terribly burned'' by losses last year, he says, such as in Mexico. Still, investors should ''cautiously'' consider including some international equities as part of their larger investment strategy, Mr. Mobius says.

Mobius, who oversees almost $7 billion in mutual-fund assets, says global investors should focus on inexpensive, well-managed companies and not just buy stocks from specific countries or regional markets. That's why, he says, he is ''constantly traveling throughout the world,'' looking for promising companies, no matter where they may be located.

Why the infatuation?

In recent years, hundreds of thousands of United States investors have turned to ''international'' stocks and ''emerging market'' stocks.

In addition to high growth rates abroad, which drive up stock prices, part of the infatuation involves supply: With more overseas nations adopting market-based economies, two-thirds of all publicly traded equities are now located outside the US. And buying international equities fosters instant portfolio diversification, since not all stock markets move in tandem. Often when the US market dips, other markets rise, and vice versa.

During the first quarter of this year, domestic mutual-fund stock indexes were up; but international mutual-fund stock indexes were down, according to Lipper Analytical Services Inc.

In a discussion of non-US stocks, several distinctions are necessary. In terms of safety, financial institutions generally distinguish between ''international'' stocks found in well-regulated industrial nations such as Britain or Germany, and ''emerging market'' stocks, found in nations with less developed economies and less-regulated financial markets, such as Brazil or Peru.

Second, the US mutual-fund industry distinguishes between ''international'' and ''global'' funds. ''International'' stock mutual funds comprise stocks sold entirely outside the US. Global stock funds, by contrast, can carry a mix of overseas stocks and some US companies.

You can buy overseas stocks through mutual funds (the most popular approach) or with American Depository Receipts, or ADRs, of foreign stocks. Stock of US multinational companies with significant international operations reflects overseas developments.

Unlike mutual funds, ADRs are largely unknown to most Americans. An ADR represents a share or series of shares in an overseas company and is denominated in US dollars.

Let's say you want to buy shares in Japanese electronicsmaker Sony Corporation. Sony is an ADR listed on the New York Stock Exchange (NYSE). The process is no different from buying an American company, says Jean Wiegner, a financial consultant and broker with Merrill Lynch & Co. in Princeton, N.J. To purchase the issue, you would pay a regular broker's commission. The underlying price of an ADR can be influenced by changes in currency valuations -- in the case of Sony, between the yen and the dollar.

The difference between buying an ADR and a stock directly from abroad is that the ADR, by being listed on a US exchange, is subject to US securities regulations. Moreover, the paperwork involved is handled within the US. If you were to buy the stock directly from abroad, the paperwork would be more cumbersome.

Less risk with ADRs

The investment might also be riskier if the overseas market is not as well regulated as US markets. Moreover, any subsequent legal ramifications surrounding the stock -- such as what might happen if the American purchaser were to die and leave the stock to his heirs -- could be subject to the laws of the foreign country, Ms. Wiegner says.

Foreign accounting standards can be weaker than in the US, adding some risk, experts say.

The purchase of US companies with a strong overseas component is a conservative approach. In fact, US blue-chip, multinational companies may be the best-positioned of all US stocks during the next few years, says Restor Johnson, a managing director with investment house Dain Bosworth Inc., in Minneapolis.