Roanoke Times
                 Copyright (c) 1995, Landmark Communications, Inc.

DATE: MONDAY, May 22, 1995                   TAG: 9505230007
SECTION: MONEY                    PAGE: 8   EDITION: METRO 
SOURCE: JANE BRYANT QUINN WASHINGTON POST WRITERS GROUP
DATELINE: NEW YORK                                LENGTH: Medium

WHY INVESTING IN FOREIGN STOCKS ISN'T ALWAYS WISE

The first choice of savvy investors has always been a widely diversified fund invested in the strongest companies in the industrialized world. When you study the foreign-stock indexes, these stocks have yielded better returns than American stocks for the past 20 years.

What's more, by diversifying into foreign mutual funds you should reduce your risk. When U.S. markets drop, other markets may rise, putting a cushion under your potential for loss.

Anyway, that's the theory. But on closer examination, this theory doesn't always hold up, according to Rex Sinquefield. His firm, Dimensional Fund Advisers in Santa Monica, Calif., runs more than $10 billion in mutual funds for institutions and clients of fee-only financial advisers. Here is Sinquefield's five-step contrarian view:

The stocks of other industrialized countries have not, in fact, been doing better than American stocks. Measured in their own currencies (yen, marks, francs and so on), they have actually done worse. So far this year, the most popular international stock index (called EAFE, for Europe, Australia and the Far East) has dropped 5 percent in local money, compared with a spectacular 13 percent rise in the Standard & Poor's 500-stock index.

Why, then, have the foreign-stock indexes looked so good? Only because the dollar has been weak. When the dollar goes down against the value of other currencies, the value of stocks held in those currencies goes up. In other words, we've been making money by speculating against the dollar, not because of superior growth in corporate profits abroad.

Here are the comparisons that matter, for the popular EAFE stocks. Measured in foreign currencies, they yielded 10.4 percent over the past 10 calendar years, according to Morgan Stanley Capital International. But translated into weak U.S. dollars, those same stocks yielded a fat 17.9 percent.

Over the same period, the S&P 500-stock index yielded 14.3 percent. So foreign stocks looked better - but purely because of the falling dollar. If the dollar goes back up, foreign stocks won't look so hot.

Surprisingly, the big international funds haven't even done much, in recent years, to ease the pain when American stocks fell. Big foreign stocks are behaving pretty much like big U.S. stocks, Sinquefield says, rising and falling at about the same times.

For a truly diversified portfolio that should reduce your long-term risks, you don't need the big international funds. You'd earn better returns, Sinquefield believes, by bringing that money home. Invest it instead in U.S. small-stock funds and the so-called ``value'' funds. (``Value'' companies, often those that are temporarily troubled, carry low market prices compared with what the firm is worth.)

If you do want to keep some money abroad - which Sinquefield advises - look beyond the traditional diversified funds. Sinquefield thinks you'll earn more from foreign value funds and foreign small-stock funds.

Here's a sample portfolio, using the Vanguard Group of funds, that come close to matching Sinquefield's recommendations for a moderately aggressive investor:

Put 10 percent of your money into Vanguard's 500 Portfolio (which tracks the S&P 500-stock index), 10 percent into the Small Cap Portfolio (for small U.S. stocks), 20 percent in the Value Portfolio (for U.S. value stocks), 40 percent in the U.S. Short-Term Bond Portfolio (to be conservative) and 10 percent in Trustees' Equity-International, which is a foreign value fund. All of these funds track standard market indexes.

There aren't any small-stock foreign funds that track a standard index. So, for the remaining 10 percent of your portfolio, you'll need to choose a foreign small-stock fund that's run by a professional manager.

Two that meet Sinquefield's specifications are Founders Passport and Montgomery International Small Cap. Alternatively, you might want to put some money into an emerging market fund.

Sinquefield's theory has plenty of critics. Josef Lakonishok, finance professor of the University of Illinois at Champaign-Urbana, thinks that small stocks won't do as well in the future as they did in the past. Marshall Blume, at the Wharton School in Philadelphia, finds EAFE more useful than Sinquefield allows. But they both agree that value funds are a good idea and should outperform over the long run.