By Michael Molinski, Investing Across Borders

May, 2001

SAN FRANCISCO – Think of the riskiest categories of stocks over the past few years, and the words "technology" and "international" are likely to be among the first that cross your mind. If you combine the two -- international technology stocks -- you get something akin to running with the bulls in Pamplona, right?

Wrong! As counter-intuitive as it may sound, global sector mutual funds can actually be less volatile than U.S. sector funds, and adding them to a portfolio that is dominated by large-cap U.S. stocks is a good way to reduce some of your overall portfolio risk.

International stock funds tend to be more volatile than U.S. stock funds. And tech funds, biotech funds and financial sector funds are hugely more volatile than index funds.

However, a recent study by fund-tracking firm Wiesenberger found that global technology funds are actually less volatile than domestic technology funds, with a standard deviation of 47.65 versus 61.62, meaning their day-to-day closing prices don't stray as much from their average price. (Global health care, financial and utility funds, however, all showed slightly higher standard deviations than their domestic counterparts.)

Adding a global technology fund to an all-domestic portfolio, for example, can reduce the overall risk level of your investment portfolio because foreign stocks don't move in tandem with U.S. stocks. With a global fund, therefore, you reduce your exposure to a big drop in the U.S. market. Plus, the potential for higher returns can be greater.

"Most global sector funds capitalize on both the growth in the United States and the growth overseas," said Ramy Shaalan, a fund analyst at Wiesenberger. "Most are allowed to put up to 70 percent in the United States, but when opportunities such as wireless or the Internet in Europe come up, they can very flexibly move assets to those regions."

While global sector funds might seem like good complements to a domestic sector fund, many global sector fund managers are trying to position their funds as competitors. They want to be the one technology fund you invest in, or the one health care fund, or what have you.

And investors are taking notice. There are now 42 global sector funds traded in the United States, seven of which started in 2000, and they now account for more than half of the $217 billion in assets in all global equity funds, according to Wiesenberger.

It's important to keep in mind that global sector funds are "global" funds, and not "international" funds, meaning they can invest in both foreign and U.S. stocks. There are few pure international sector funds out there, mostly because fund managers are wary of the added volatility and want the flexibility to be able to switch into U.S. stocks when they're rallying.

Global sector funds also tend to invest in smaller companies than the average diversified global fund, which has its pluses and minuses. Smaller tends to mean riskier, but it also means that global sector funds tend to have lower correlations to the U.S. stock market than do large global funds and thus are more insulated from U.S. business cycles. International small-cap funds have also out-performed their larger cousins in recent years, averaging 13 percent a year over the past three years versus 4.5 percent for all international funds, according to fund-tracking firm Lipper.

If you're looking for variety, however, you won't find much of it in global sector funds. Only four sectors are represented: technology and communications, health care and biotech, finance and utilities. There are only four funds in each of the latter two categories.

Another drawback is youth. Most global sector funds are less than three years old, meaning there’s not much of a track record to make comparisons.

Global sector funds aren't for everybody, and they're certainly more volatile than the average international or domestic generic equity fund.

Still, if you believe the U.S. stock market is in a long-term bear or sideways trend, global sector funds are one way to add a single industry's growth to a portfolio while at the same time taking advantage of the fact that the rest of the world might outperform the United States. And if you're the type of investor that enjoys roller coaster rides and can stomach the pitfalls, they're a lot more exciting than some of the generic global and international funds on the market.

Finally, they're a way for investors who prefer to pick their own stocks to get exposure to overseas investments that they may not be comfortable investing in through American Depositary Receipts. Choosing a top German automaker or a blue-chip Japanese technology company is one thing, but trying to pick a winning South American telecom company or Central European restaurant chain is something that may be best left to the experts.

Michael Molinski is president of Investing Across Borders LLC. Previously, he was International Editor and Mutual Funds Editor at CBS MarketWatch and a veteran foreign correspondent for Bloomberg News.