Alan S. Moore / L’Observateur / May 17, 2000

Foreign stocks did not shine relative to the domestic equities market during most of the 1990s. That is very clear when you examine the performancerecord. Between 1989 and 1998, U.S. stocks earned an average annual totalreturn of 18.1 percent, as measured by the Wilshire 5000 index that tracksmost regularly traded U.S. stocks. During the same period, internationalstocks returned an annual average of just 5.9 percent, as measured by theMorgan Stanley Europe, Australia, and Far East (EAFE) index.

Better Times

On the other hand, foreign stocks have significantly outperformed domestic issues during some past periods. For example, from 1970 through 1979, theaverage annual total return of the EAFE index was 11.13 percent, butStandard & Poor’s 500 Stock Index (measuring large capitalization domestic stocks) returned only 5.84 percent. The 80s, too, were a winning period forforeign stocks. The EAFE index returned 21.98 percent from 1980 through1989, when the average annual total return of the S&P 500 was 17.55percent. Over a longer holding period, domestic and foreign issues finishedneck and neck. Both indexes earned the same 13.7 percent average annualtotal return over the 28 years from 1971 through 1998. Through the firstnine months of 1999, the EAFE index gained 8.75 percent, while the S&P 500grew 5.36 percent.

Currency Risk

An international investor takes on considerably more risk than a domestic investor. The dangers of investing abroad include currency risk – ongoingfluctuations in the values of foreign currency relative to the U.S. dollar(exchange rates) and possible devaluations of foreign currency. Either maygreatly depress the dollar returns a U.S. investor earns on foreigninvestments – regardless of how well the underlying securities themselves perform. Of course, currency shifts may also increase dollar returns. Thereis no way of knowing in advance which it will be.

Political and Legal Risks

Exporting money also exposes it to both political and legal risks. Companiesabroad may be nationalized. Foreign governments may impose heavy taxes,repudiate debts, expropriate assets, or restrict business activities and trade. War or revolution may erupt, etc. You can gain a vivid idea of theproblems that are possible simply by following the daily international news. Inaddition to political and legal risks, the normal market, company, and economic risks of domestic investing are also present abroad.

A Bad Bet?

Some investors argue that the parity in the long-term (1971-1998) returns of foreign and domestic stocks combined with the additional risks make foreign stocks an undesirable element of a diversified stock portfolio. Higherrisk for the same potential return simply looks like a bad bet.

However, this thinking discounts the enhanced diversification and consequent additional risk control that foreign stocks (or foreign stock funds) bring to a portfolio. Domestic and foreign stocks do not necessarily move in sync. Theirhistorical performances show considerable differences and, at times, foreign stocks have been the better performers. The potential clearlyexists that – in some periods – gains in foreign stocks may offset the weaker performance of domestic stocks, as happened in the second half of the 1980s. That gives foreign issues a place in a well-diversified stock portfolio.Bear in mind, however, that foreign investments differ in quality, just as domestic securities do.

Your Move

Despite the additional diversification they provide, foreign stocks do not necessarily belong in your portfolio. Your individual objectives and riskpreferences must determine that.

You may want to seek professional investment advice before you make any decision to send your money abroad.

ALAN S. MOORE, a financial advisor of Legg Mason Wood Walker, Inc., writesthis column every Wednesday for L’Observateur.

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