Friday, May 02, 2008

Why are my international investments doing so well?

May 2008 - Do you ever wonder why, lately, your foreign investments seem to grow at 20-30% while your domestic ones grow closer to 10%? For example my American European Pacific Growth Fund has an annualized three year return of almost 20%. On the contrary, my Growth Fund of America fund has a three year annualized return of 12.47%. Are the international companies that much better than American ones? No. Have international companies found unexplored markets with endless growth? No. So what is happening?

While a youngster in college, I joined a large group of friends that went to spring break in Mexico. I actually did it three times, and only remember bits and pieces of each of them. If you throw out drinking and socializing with friends and new friends, exchanging money was my favorite activity. For some reason I really enjoyed walking up to the exchange window and cashing in my U.S. dollars or Travelers Checks for paper with a picture of some Mexican nobles.

Back then I could get eight Mexican pesos for a dollar. That would buy you three to four beers on the beach, if I remember right. I just checked and today you get 10.5. That is, the dollar as appreciated 24% against the peso since my college days.

Now, let's say that I met a seemingly successful business woman or man in Mexico and invested one dollar in their company, or in other words bought one share of stock for eight pesos. And for simplicity, let's say that things didn’t turn out as expected with the business and they only covered their expenses for the past ten (or so) years. That is, my eight pesos have just been setting there not gaining any equity leaving my stock worth eight pesos. Having enough with that investment, today I decide to take my eight pesos back. Well guess what, the eight pesos they give me now is only worth 76 cents. Hey, I just lost 24 cents on this investment, yet my stock price did not change?

Let's take this example and reverse it. Say I'm a Mexican and went to Minnesota for spring break (yes that would be crazy) and made a similar investment. That is, I purchased a one dollar stock for eight pesos. And now ten years later, I wanted to sell my one dollar stock and get my pesos back. Since the dollar had appreciated 24% against the peso, when I sell my one dollar stock I get 10.5 pesos back. Hey, I just made a 24% return!

This simple example explains why my (and your) foreign investments have been doing so well. The dollar has been depreciating the past few years, which made foreign returns look bigger than they actually were.

Should we continue to invest internationally? I argue that you should be globally diversified, meaning you should continue to invest a portion of your assets globally. However, remember that some day the dollar may appreciate again and you could end up taking a major hit. Keep that in mind before you toss all your savings into an international investment.