International Exposure With Less Risk

Get out of town
These days, I spend a lot of time looking overseas. It's not just that I love to travel, although I certainly do. It's because I'm more and more convinced that I should be investing a larger percentage of my portfolio in companies that operate outside the United States.

Investing overseas can provide some very desirable diversification for our normally U.S.-centric equities portfolios. In other words, if Mr. Housing Bubble pops over here and the strip malls suddenly empty, putting the hurt on my retail stocks, I can be reasonably certain that folks in China will continue to guzzle oil products from PetroChina.

But I'm not just looking for a safety net. I'm also looking for opportunity, and I believe there may be more of that outside our borders. Indeed, on the basis of global demographic and economic trends, Jeremy Siegel argues very persuasively in The Future for Investors that we should keep up to 40% of our investments in foreign firms.

Get your reading glasses
But if you think investing in U.S. companies takes work, just try digging through foreign filings. What looks like a clear investment case on the surface can be turned upside down by any number of complications. Take insane ownership structures. India's TataMotors (NYSE:TTM) looked good to me until I realized I could not come to terms with the Tata empire. Encompassing everything from chemicals to hotels, tea, and tractors, it makes GM's (NYSE:GM) corporate structure look like simplicity itself.

But even when you've got a simpler situation, disparities in national laws or generally accepted accounting practices (GAAP) can render your usual research ineffective. Let's take an example.

By these numbers, Coca-Cola's (NYSE:KO) cousin, Mexican bottler Coca-Cola FEMSA (NYSE:KOF), looks like a much better deal than its stateside relative, Coca-Cola Bottling (NASDAQ:COKE). FEMSA trades at a sweet-looking earnings multiple of 12, versus 18 for the U.S. company. Return on equity seems a lot slimmer, although return on capital looks better. But is it really a deal? What's the right "Mexico discount," if any?

And just how analogous are these metrics? Can you fairly compare ROE and ROC when Mexican companies have vastly different tax situations and must, by law, put 5% of net profits into a legal reserve, until that reserve reaches 20% of capital stock? Hint, the answer is "No," or at least, "Not without some adjustments." As any traveler can tell you, simple tasks get a lot more complex when you cross the border.

Indexing the answer?
Are you up to that extra work? If not, you might think the easiest way to score overseas would be to simply drop your money into a hot country index, such as iSharesFTSE/Xinhua China 25 Index Fund. This exchange-traded fund (ETF) has turned in some solid performance since its inception, doubling the S&P 500's return since the fall of 2004. Whether that continues is another story.

Unfortunately, as Siegel's book also makes clear, boomlets in sectors or economies -- the kinds of things that get folded into indexes -- don't necessarily translate into returns for investors. The reason is that companies tend to be added to indexes when they reach a certain market capitalization -- which is, too often, when they are most overvalued. (Think of Yahoo! and the other bubble wonders entering the S&P 500 back in the bad old days.) Buying high, as stock indexes do, is not the route to the best returns.

If buying indexes isn't a sure win and researching individual companies is too much work, what's left? Well, there are those managed funds.

Knowing when you're licked
Keep in mind, you're hearing this from an avowed stock guy. I would always rather choose my own investments. But my stubbornness knows some bounds. For instance, I know that it's going to be a long time before I come to terms with GAAP in India, Mexican tax law, or Brazilian ownership structures. That's why, when it comes to foreign investing, I'm willing to hand some of my money to the pros, provided I can find a pro with a good track record.

The trouble is, finding a good, inexpensive international stock fund can be a mission impossible. Just try any of the Web screeners out there and you'll see what I mean. Expense ratios can be outrageous, and I recently came up with one that had a minimum buy of $3 million. Three million? (If I had that kind of scratch sitting around, I'd have already spent it on a beach shack and some T-bills. I certainly wouldn't be working up a bigger hunchback banging out articles five days a week.)

A fund worth watching
One of the funds on my wish list is the Dodge & Cox International Stock fund. Among the fund's top holdings are a couple of firms I've been watching, GlaxoSmithKline (NYSE:GSK) and Mitsubishi UFJ (NYSE:MTU). It holds a relatively slim selection of stocks (just six dozen), so I know I'm not getting a glorified index fund. And it's got a turnover rate for 2005 of 7%, so I know I'm not getting frenetic traders. Finally, it sports a dirt-cheap expense ratio of 0.77% and has low minimum buys.

Foolish bottom line
International investments definitely have a place in your portfolio, but even the most stubborn stock picker should enter foreign waters with care. Make sure you do your homework, and don't be afraid to start out with some expert advice. A couple of foreign funds can provide a solid base for your overseas investments, and you can add individual companies as you become more familiar with the turf. In fact, the best place to start your research would be the companies held by your funds. Once you know why those firms look like buys, you'll be better equipped to find foreign bargains on your own.

I'm not surprised to find out that the foreign funds I screened up are already recommendations of Motley Fool Champion Funds . For a look at other foreign champs, as well as domestic, bond, and other funds, a free 30-day guest pass is available. Did I mention that 78% of lead analyst Shannon Zimmerman's picks are beating the market, and doing so by an average 11 percentage points?

Coca-Cola is a Motley Fool Inside Value recommendation, and GlaxoSmithKline is a Motley Fool Income Investor pick.

Seth Jayson hopes to follow his money offshore one day. At the time of publication, he had shares of PetroChina but no positions in any other company or fund mentioned here. View his stock holdings and Fool profile here. Fool rules are here.