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October 9, 2006 10:15 pm

Hunt abroad for flourishing profits

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You knew it was wrong but you could not help yourself. Besides you had done such a good job divvying up your domestic mutual fund portfolio – you had growth, value, blue chips, small- and mid-caps, basic bonds, even an income fund for good measure – that when it came time for your international allocation, it was understandable that you got tired.

Out of fear or ignorance or laziness, you chose only one other fund to represent the rest of the world’s investment returns. And now, as many international economies flourish, your portfolio is losing out.

And that is painful be-cause, as the chart shows, the rest of the world has been a much more profitable place to hunt for returns in the past few years.

There is a way to remedy the situation. Several asset managers – including Oppenheimer, MFS and ING – have launched international diversification funds of funds within the past year. These funds, which invest only outside the US, have exposure to several international asset classes. This gives you steady allocations to all the main areas that are already a part of the diet for domestic funds – large-cap growth, value, core, small- and mid-cap for the developed economies, and emerging markets.

The idea is that they provide greater diversification to a US-based investor than any single-strategy international fund, says Owen Concannon, research analyst at Financial Research Corporation, the Boston-based data company.

“They’re a relatively new phenomenon and they’re certainly good products because advisers and individual investors don’t have time to do the [international] allocation,” he says. “A diversified international equity fund is the perfect answer, particularly with smaller balance accounts, because at that end of the spectrum, you’re not going to buy three or four international funds – you’re going to buy one.”

It is no coincidence that these funds have been created when returns from international markets are solid. According to FRC, investors are flocking. The MFS International Diversification fund has taken in $587m so far this year. Meanwhile, the Oppenheimer International Diversified Fund has attracted $409m and the ING Diversified International fund has re-ceived $201m.

Thomas Melendez oversees MFS’s international diversification fund, which laun-ched in October 2004 and has $1.2bn in assets. The primary benefit, he says, is that investors can have a fully diversified portfolio of international securities and bonds in one fund. This lowers volatility.

“As investors have become more sophisticated and comfortable with international markets, there is a growing demand for style-specific investments,” he says. “So we put it all together under one umbrella.”

The MFS fund has 35 per cent in core international equities, 25 per cent in international growth, 25 per cent in international value, 10 per cent in the Discover fund (covering small- and mid-cap equities) and 5 per cent in emerging markets.

“The fund of funds allows investors to access five distinct disciplines without making a disproportionate bet on any one style or in any one part of the world,” Mr Melendez says. “Essentially what we’re trying to do is lower the risk and increase the reward.”

As a fund of funds, the goal is “not to be smarter than the market”, according to Mr Melendez. “We don’t want to be momentum players. We have a static allocation so that investors know where they are . . . The asset allocation is strictly a by-product of where we find great companies.”

The Oppenheimer International Diversified fund, which launched last year, is similar. The fund can invest in up to seven other Oppenheimer funds. At the moment, the $520m fund has 30 per cent in international growth, 30 per cent in international value, 15 per cent in international small-cap, 15 per cent in emerging markets and 10 per cent in international bonds.

George Evans, director of international equities at Oppenheimer Funds, oversees more than $40bn in assets. He says the fund’s multi-disciplinary approach offers investors “a one-stop shop for all asset classes”. He adds that the fund is diversified because there is little duplication of stocks. “Quite often in investment management groups, you have a commonality of approach. But in this fund there is relatively low cross-over between the funds so you’re not looking at replication of investment effort.”

The ING Diversified International fund – which laun-ched in December last year – invests in seven ING international funds. At the mo-ment, the $188m fund has 30 per cent in its index fund, 23 per cent in its foreign fund, 21 per cent in its capital appreciation fund, 14 per cent in its value fund, 8 per cent in small-caps and 4 per cent in emerging countries.

It may also make a modest allocation to international real estate, says Martin Jansen, senior portfolio specialist for international equities. “As an asset class, real estate is not as strongly correlated with the others and so it could help us achieve smoother, more balanced returns,” he said. “International real estate has done phenomenally well in the past couple of years but we see more opportunities opening up in 2007 and 2008.”

There are some disadvantages to investing this way, Mr Concannon says. Take the lack of customisation, for instance. “You lose control of the allocation. And you might not be happy that certain asset classes are missing or under-represented,” he says.

Fees tend to be high, as well, he says. “Traditionally, international funds have higher fees than domestic funds and when you wrap an allocation fee on top of that it can get expensive.”

Still, Mr Concannon says, the fund of funds model seems to be catching on. “It’s got legs and I wouldn’t be surprised to see it carry over into other areas like alternative investments.”

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