Buy The World

By Daniel Kadlec, Jyoti Thottam

After this summer's market meltdown and the dollar's fall against the euro, who could blame the weary, wary American investor for seeking shelter overseas? Investing abroad is a logical choice to balance your portfolio. But how much? And where? Time senior writer Daniel Kadlec and reporter Jyoti Thottam asked three top portfolio managers, Gary Bergstrom, chairman of Acadian Asset Management; Barton Biggs, chairman of invest- ment management for Morgan Stanley; and Sarah Ketterer, CEO of Causeway Capital Management. Here are their top picks among overseas markets and some advice on the smartest ways to diversify globally.

TIME: With the damage that has been done, what is your outlook for the U.S. market?

BARTON BIGGS: The market has had a big rally, but sentiment is still very bearish. The weak dollar and lower interest rates may result in profits being better than expected later this year and next. It's a time to be a buyer of equities, not a seller.

SARAH KETTERER: If international markets do go down another 5% or 10%, it makes it all the more a buying opportunity. We see outside the U.S. in the developed world valuations more attractive than they have been for the past five, six years.

GARY BERGSTROM: We have been through an almost classic waterfall and are due for at least a decent rally for a while. Where I take issue with other people is in the longer-run outlook for equity returns. You have to be a wild bull on U.S. earnings growth to get even high single-digit numbers out of the S&P 500 over the next five to seven years.

TIME: If the U.S. stock market does not sustain this rally, doesn't that spill over into the global markets?

BIGGS: Not just the world markets, the world economy too. The bear case is that we are going to have a double-dip recession because the further decline in the stock market will have such a severe wealth effect that the American consumer, who has been the engine of the U.S. economy and the world economy, is going to fade significantly.

KETTERER: We can't call the bottom, and individual investors shouldn't even try. The key is to discipline yourself to putting money in and not trying to call either the top or the bottom.

TIME: Your advice to individual investors would be to keep putting money in?

KETTERER: Absolutely, and do so on a regular basis in manageable increments.

TIME: The European markets have been devastated as well, so the question is, How do you persuade somebody to buy into yet another market that has been creamed?

KETTERER: The major case is diversification. Non-U.S. markets are now less volatile. When you mix a lower-risk asset class into your U.S. portfolio, by definition you lower your risk.

BERGSTROM: There are some equity markets in the world that have been very good places to be, even during this U.S. bear market. Korea is one. That may be one of the simplest ways to say, Hey, there are diversification opportunities.

TIME: Some U.S.-based investors believe they get plenty of international diversification by owning Gillette and Coca-Cola and all these multinationals. Is that a good way to diversify?

KETTERER: No. What you want to do is add stocks to your portfolio where the share price is not driven by the U.S. investor.

BERGSTROM: There have been a number of studies that analyze the data and underscore the point that you don't get that much diversification from a portfolio of multinationals that are primarily priced in New York.

TIME: Where will the U.S. market fit in globally over the next five to 10 years?

BIGGS: It is going to be the worst-performing major market in the world. That doesn't mean it is going to go down; it just means it is going to go up less than Tokyo, Frankfurt, London. A combination of high valuations going in and slow growth coming out is going to make it an underperformer.

BERGSTROM: Taking a five- or 10-year perspective, the U.S. equity-market returns on average are likely to be subpar. Some but not all emerging markets are likely to be the potential equity-market stars.

KETTERER: The one huge advantage the U.S. continues to have over Japan and Europe is flexibility of labor. That doesn't diminish the argument against diversification internationally, particularly without the headwind of a stronger dollar. Americans investing abroad in the past five years have had this headwind all along, and now it is payback time.

TIME: What is your outlook for the dollar, and how important is it?

BERGSTROM: We would look for a gradual erosion of the value of the dollar from here.

BIGGS: It is going to be another factor adding to international returns. Investing internationally has paid off this year because the dollar has gone down so much that international funds are down 7% or 8%, compared with other funds that are down 20% or 25%. TIME: What's the best way to get some international exposure? How much of the stock portion of your portfolio should be in international equities and, within that, how much in emerging and developed markets?

KETTERER: We'd advocate a healthy 40% allocation of your equity portfolio to non-U.S. stocks. You need to have at least 30% to 40% there to get that benefit, but any amount is good to start. Again, this concept of regularly investing in and adhering to a program of asset allocation and rebalancing--rebalancing is an incredibly healthy exercise because it forces you to put more money into whatever asset class has not performed well.

TIME: Rebalance every year?

KETTERER: Every six months. time: Emerging vs. developed market?

BERGSTROM: In a medium-risk strategy, we had 15% inflation-index bonds, 5% high-quality fixed-income bonds, about 15% in high-yield bonds. We had about 30% in developed-market, non-U.S. equities, about 10% in U.S. equities, 12% in emerging-markets equities and about 12% in real estate-related investments.

BIGGS: For the individual, 25% in the international markets is enough. Investing outside your home currency is a big deal.

TIME: Isn't it possible to find a manager who will protect you from those risks?

BIGGS: Any investing outside the U.S. should be done through the form of funds. Individual investors should not buy any individual stocks.

BERGSTROM: In emerging markets, U.S. investors should look only to well-managed commingled funds. It is silly to try to do it on an individual-stock-picking basis.

TIME: The easy way would be to index. You can index any country now.

BERGSTROM: For individual investors, I would not recommend they go out and buy single-country exchange-traded funds or closed-end funds. Sure, if they are smart enough, they can do it right and make money. But I don't think that is a game that most individuals are prepared to do successfully.

TIME: Can we talk about which international markets offer the most promise?

BIGGS: Singapore, because it is going to be the financial center of Asia or at least of Southeast Asia in the future. It is a very well-run, orderly economy and stock market. And I would say Japan, because Japan has already been through a depression and deflation and through a truly incredible bear market, where the index is now down 75% from its highs and where stocks are really, truly cheap.

TIME: What gives you confidence to talk about Japan now?

BIGGS: Absolutely nothing. I just believe in the Japanese, and history shows that the Japanese economy is going to recover.

KETTERER: I want to comment on Japan because it is so controversial. I don't think value in Japan relative to the other markets we have to choose from is nearly as attractive at present. We are not finding as many stocks. Japanese companies are often much less profitable than their foreign competitors in many different industries, and that has a lot to do with high labor costs and inflexible labor practices.

BERGSTROM: We tend to favor Korea a bit over Japan. Korea is up 25%, 30% year to date on most of the broad indices. The economy is growing nicely. It is not a terribly expensive market. One sort of oddball market we like is Malaysia. We see some political change coming that probably is going to work. The market is relatively inexpensive; there are some good companies there. We see some opportunities in China. It is a very chaotic place. It is about the last place in the world I would recommend individual investors try unless they--maybe--buy them in Hong Kong.

KETTERER: In our Hong Kong portfolio, the most promising stocks are the Chinese independent power producers, like Huaneng Power. They have so much return potential in industries that are massively restructuring.

TIME: Where else are you finding value?

KETTERER: All the European markets. Switzerland--plenty of financials as well as some health-care stocks. Germany--lots of financials there and other health care. In the U.K., Vodafone--investors have sold it off willy-nilly, along with other wireless and telecommunications providers in general. Also in the U.K. we like some of those that have been thrown out with the bath water--Cadbury Schweppes, for example. In the U.S. it owns Dr Pepper/7 Up. France has turned out a number of interesting opportunities for us. Investors are terribly worried, and they have dumped European financials from their portfolios. One of those in France is Axa, Europe's second largest insurer. Axa's dividend yield is now over 5%--unheard of!

BIGGS: In Europe, I'd say Germany and Spain. If the European monetary union is going to do well, Germany, the most cyclical market in Europe, is going to do well, and Spain, perhaps the most gaudy potential-growth market, is going to do well. I'd throw in there a small position in Russia just for the bang for the buck.

TIME: The Russian market is up hugely in the past year, isn't it?

BIGGS: It has come back quite a bit. BERGSTROM: Some of the major Russian energy companies are selling for somewhere between four and eight times reasonable expectations of earnings for next year. Whereas if you take ExxonMobil--basically in the same business--things are changing fast, but they probably sell closer to 20 times earnings. We would expect some of those differentials to start to shrink.

TIME: What emerging markets would you absolutely avoid?

BERGSTROM: We don't particularly like Argentina. Pakistan frightened everybody last year. Sri Lanka. India. We are not too keen on Brazil.

TIME: Any final thoughts?

BERGSTROM: I think that most individual investors do need to get a little more of a strategic asset-allocation framework. You need a systematic game plan in place in terms of a reasonably diversified portfolio and a strategy for implementing it, so that you don't push the panic button every time the stock market drops sharply. This is Investing 101.

KETTERER: It comes down to one word: diversification. That helps make the case for international, and that helps make the case for every other asset. The worse off you are, the more you ought to be disciplining yourself to put more money in.