Foreign Markets Fraught With Currency, Other Risks

When investing in foreign stocks was the rage a couple of years ago, there were a few voices lost in the crowd saying: “Hey, by the way, you could get banged up out there.”

Boy, were they right.

Now, with Mexican stock prices beaten down, it’s tempting to see this as a chance to buy into Mexico cheap - or, for that matter, into any other “emerging” markets hammered by the ripple effects of the peso crisis. And foreign investments are easy to make because of the proliferation of mutual funds that buy stocks overseas.

But this is also a good time to reassess the special risks of foreign investments, which can be pummeled by currency fluctuation, political crisis and economic turmoil. One sign of that: Nineteen emerging markets followed by Morgan Stanley were down an average of 10.7 percent in January.

And few analysts expect Mexican stocks to bounce back to their mid-December levels anytime soon. The Wefa Group Inc., of Bala Cynwyd, Pa., predicts a severe recession in Mexico this year, coupled with a near-quadrupling of inflation to 23 percent.

“Paradise has been postponed,” says William LeFevre, of the New York brokerage Ehrenkrantz King Nussbaum Inc. LeFevre, who puts out a widely read newsletter, believes that many investors were oversold on the high returns possible in foreign stocks.

Measured in dollars, Mexican stocks have fallen by almost half since the peso devaluation of Dec. 20, and some funds run by U.S. mutual-fund companies have done even worse.

Shares in the Wright EquiFund Mexico National Fund, a tiny mutual fund that buys only Mexican stocks, traded for more than $10 each in mid-December. On Jan. 30, those shares hit a record low of $4.13.

This is not exactly what investors were led to expect back in 1993, when the touts said small economies had more room to grow than big ones, so returns in emerging markets would be better than in the United States.

Sure, foreign funds had some dramatic returns in 1993. But in the final quarter of 1994, there was not a single foreign fund among the top-25 performing mutual funds, according to Morningstar Inc.

Many Americans, says LeFevre, simply don’t understand the role played by shifting currency exchange rates. When you write a check to an American mutual fund company that runs a foreign-stock fund, your dollars are converted into foreign currency, which is used to buy foreign stocks. When those stocks are sold, they bring in foreign currency that has to be converted to dollars for the American investor.

“You can be dead right on the direction of the stock, but because of something that happens in the currency, you can end up losing,” says LeFevre.

Because the typical foreign mutual fund includes stocks from a number of countries, it’s impossible to accurately assess currency risk, he says.

Sometimes currency fluctuation works in an American investor’s favor, as it did last year when the dollar sank against the yen and made Americans’ investments in Japan more valuable.

But in Mexico, the opposite happened.

If you had put $1,000 into Mexican stocks Dec. 19, at that day’s exchange rate of 3.5 pesos to the dollar, you would have had 3,500 pesos’ worth of stock. Mexican stocks lost 10 percent of their value between Dec. 19 and Feb. 1, reducing the value of your investment to 3,150 pesos. And by Feb. 1, the peso had fallen to 5.4 to the dollar. If you sold the stock and converted your 3,150 pesos back to dollars at the new exchange rate, you would have received just $583, a 42 percent loss.

The lesson from Mexico isn’t that emerging markets are a bad thing and we should all stay home. Rather, it’s that these are very volatile markets where the prospects of earning especially high returns are offset by the higher risk of loss. So if you’ll need your money for next month’s mortgage payment - or even next year’s college tuition - be wary of foreign funds.