- 2002: Volume 11, No. 1 The Derivatives Desk: Are You Sending Your Money on Tour?

Maybe you don't feel like traveling in times like these, but that doesn't mean your money is housebound. You may, in fact, be sending part of your money offshore without even knowing it.

Have you looked inside your sector funds recently? You may be surprised to learn of your money's wanderlust. Of nearly 100 sector funds that've been around five years, the average foreign stock exposure, according to recent Morningstar data, has been 12 percent. ( See Figure 1.).

Figure 1

Mutual Fund Foreign Stock Exposure
Energy (22 funds) 25%	Financial (19 funds) 3%	Healthcare (22 funds) 9%	Technology (25 funds) 5%	Telecommunications (10 funds) 30%
Source: Morningstar, 11/30/01

Still, the foreign exposure in these funds hardly seems rich compared to the global large-cap stock universe. Compare, for example, the current non-U.S. weight of sectors making up the S&P Global 1200, a benchmark covering stock markets of the Americas, Europe and the Pacific. Together, these five sectors make up about two-thirds of the market capitalization of the S&P Global 1200. (See Figure 2.).

Figure 2

S&P Global 1200 Sector Foreign Stock Weightings
Energy 51%	Financial 48%	Healthcare 28%	Technology 24%	Telecommunications 54%
Source: S&P, 12/7/01

It's apparent that even when dining from a menu advertised as a "global" sector fund, your portfolio probably isn't fattening itself on the equity equivalents of crepes, sauerbraten, or Yorkshire pudding. But what's surprising to most investors is that Yankee stocks have actually been more volatile, on an absolute basis, than non-U.S. issues over the past few years. This seems to fly in the face of conventional wisdom which asserts that foreign markets are usually more mercurial.

Representing U.S. stocks within the S&P Global 1200 is the venerable S&P 500 Index. Comparing the broader global benchmark against the domestic subset, on a sector-by-sector basis, it seems that an exclusively domestic stock list has been frothier than a portfolio of combined US and international issues. (See Figure 3).

Figure 3

S&P Sector Volatility
US Global	Energy 25% 23%	Financial 32% 19%	Healthcare 20% 17%	Technology 53% 45%	Telecommunications 29% 24%
Source: S&P, 12/7/01

Now what do these numbers actually represent? Just this: the expected upper and lower variation boundaries from the past year's average price level, in a 'normal' world. In other words, if market conditions in the next 12 months were the same as they've been in the past year, there's two chances out of three that large-cap global healthcare stocks will end up plus or minus 20 percent from their average prices. Of course, these volatility figures aren't etched in stone; volatility can vary from year-to-year. Still, this kind of volatility differential has been extant for several years.

So, buying your portfolio some international tickets could have dampened overall volatility over the last 12 months. But don't start booking passage yet. What about returns? In all but one case, these global sectors actually suffered steeper losses than analogous US market segments over the past year (See Figure 4.).

Figure 4

S&P Sector Returns
US Global	Energy -11% -8%	Financial -8% -12	Healthcare -6% -7%	Technology -35% -37%	Telecommunications -22% -29%
Source: S&P, 12/7/01

With these volatility and return numbers in hand, we can simply measure the kind of risk undertaken when investing a portion of a portfolio offshore. A ratio using returns as the 'reward' and volatility as the 'risk' shows what's at stake when investing dollars in these large-cap stock lists. (See Figure 5.).

Figure 5

S&P Sector Reward-to-Risk Ratios
US Global	Energy -.44 -.37	Financial -.25 -.64	Healthcare -.30 -.44	Technology -.66 -.80	Telecommunications -.75 -1.24
Source: S&P, 12/7/01

Note that investing a dollar in the global telecommunications sector a year ago was likely to have cost $1.24 in losses, a decidely 'riskier' deal than being invested in purely domestic telecomms. On the other hand, large-cap US energy stocks were a marginally better risk proposition over that same period than a worldwide portfolio of oil and gas companies.

So, is conventional wisdom justified? Are international stocks really riskier than domestic issues? Perhaps so, at least on a risk-adjusted rather than an absolute basis. Keep in mind, though, that these findings apply to the components of the S&P indexes. Your funds' stock lists can vary considerably from these rosters. And the concentration of international stocks in sector funds can vary considerably, too. Healthcare funds' foreign stock exposure, for example, ranged from nil up to 31 percent.

One implication is clear: the closer a portfolio tracks the S&P Global sectors, the greater the degree of riskiness relative to domestic issues. Next time around, we'll look at what you can do about this, so keep your passports at the ready.

Brad Zigler has been writing about futures, options and index issues for nearly 20 years. As the head of marketing and education for a derivatives exchange and an asset management firm, his articles have appeared in numerous financial publications.