WEALTH MATTERS
Buy American? Upscale Investors Look Abroad
By PAUL SULLIVAN
Published: November 19, 2010
Well-heeled American investors have been doing something lately that they resisted for decades — becoming more like their European, Asian and Latin American counterparts and substantially diversifying their portfolios outside their home country.
There are two reasons for this. The financial crisis and the slow recovery showed them that the United States was not immune to devastating crashes of the kind that wealthy people in emerging markets have tried to hedge against by investing abroad. And second, American investors are worried that their portfolios are going to suffer for the foreseeable future, given the size of the United States’ budget deficit, the weakness of the dollar and the uncertainty over the stock market.
“I’ve never seen a period in which clients have expressed such an interest in nondollar investments,” said Kent Lucken, managing director at Citi Private Bank. “People are spreading their chips around more prudently and I think more wisely.”
What is different is how directly these investors are going into non-American markets. They are not content with buying international equities or going into an international bond fund.
They are looking to invest directly in Chinese private equity, Indian real estate, Brazilian equities denominated in reals and Australian government bonds. They are also opening cash accounts in multiple currencies.
“International clients understand the need to diversify currencies, but this is something new to U.S. clients,” said David Frame, global head of alternative investment at J. P. Morgan Private Bank.
The people putting as much as 40 percent of their portfolios into nondollar investments are quite wealthy. But consider it this way: What can investors of more modest means learn from what the wealthiest people in the country — with the best research and advice at their disposal — are doing with large portions of their fortunes?
UPSIDE Investors who lived through the 1990s will remember the crises in Asia, Mexico and Russia that shook global capital markets.
Investing internationally has always carried risks and it is by no means without perils today.
But many investors see a different trade-off, one based as much on a stagnant or declining United States as on certain international markets that are growing, if not booming.
“When you make an investment in nondollar currencies, you’re making two investments at once,” said Tony Roth, head of investment strategies at UBS Wealth Management.
“You’re betting the dollar will go down, but you’re also buying another investment. You need to be compensated for that source of risk.”
He cited the example of buying a one-year Australian government bond, yielding 5.25 percent. He said he believed that the American dollar was going to lose value and the Australian dollar was going to gain it. That’s Part 1. Part 2 is that the Australian government is stable, so an investor can count on receiving that 5 percent annual return. The alternative is less than half of a percent if invested in United States Treasuries.
“I’m going to receive a return,” he said, “that more than compensates me for the marginal risk I’m taking.”
But there are far more risky investments. And the ones that are less liquid — infrastructure in China, say, or a private equity fund in Brazil — carry more uncertainty. But like their equivalents in the United States, they provide a higher return, in theory.
Mr. Frame said clients were investing in Asian infrastructure and Asian private equity by pooling their money with other investors. “There is a lot going on when a country is growing and developing that is hard to address through the public markets,” he said.
While there’s an obvious "pull" to international investments, there is also a bit of a "push" out of the United States: investors who are making their portfolios more international are doing so because they believe that the role of the United States in the global economy is shrinking.
Mr. Roth said the United States contributed 40 percent of global gross domestic product 15 years ago and now contributed 21 percent. He predicted that that figure would fall to 12 percent in another 15 years. Going along with this is the shrinking market capitalization of American stocks compared with global stocks.
“We have the U.S. experiencing flat to 2 percent G.D.P. growth, but you have Brazil, India and China with substantially higher rates,” Mr. Lucken said. “Equity investors are investing abroad to capture higher returns and invest ahead of higher growth rates.”
DOWNSIDE The biggest risk is uncertainty, followed by a lack of knowledge. No one knows exactly what is going to happen, and there are always investors who rush in too quickly without fully understanding the risks.
Those risks run the gamut from income inequality that could create unrest, to legal systems that have not been tested by foreign investors, to managers abroad without established track records.
There is also the unforeseen. “I witnessed firsthand the collapse of the Soviet Union,” said Mr. Lucken, a former foreign service officer.
“That speaks to the unique political risks in smaller developing countries.”
Also, South Korea and Brazil, which are now darlings of investors, were shaken by crises in the 1990s. “The history of success has been relatively short — the past 10, 12 years,” said Christopher J. Wolfe, chief investment officer for the private banking and investment group at Merrill Lynch.
But Mr. Wolfe said clients were investing across all asset classes when they invested internationally and that gave them greater diversification. It is also a big change from the time when “it used to be U.S. stocks and non-U.S. stocks,” he said.
Like all big changes, there are going to be fits and starts. But after what investors lived through over the last three years at home, some are willing to chance it.
http://www.nytimes.com/2010/11/20/your-money/20wealth.html?ref=wealth_matters
Are overseas investments worth the risk? Which ones can be part of the mix for a prudent investor?
Paul Sullivan writes about strategies that the wealthy use to manage their money and their overall well-being.
