IN THE MARKETS,

we're all dumb money. But the dumbest among us constitute "the herd," the mass of slow-moving sheep that always seem to buy too late and sell too early.

My strategy has always been to watch the markets and steer clear of the herd. While I'm certainly not profitable in all of my trades, the herd rarely gets it right. So when it comes to choosing investment strategies, my goal is to find out where the herd is, and go somewhere else.

Generally speaking, the biggest component of the herd is probably mutual-fund investors. While there are plenty of razor sharp individuals out there using mutual funds, as a group they tend to have less-than-perfect timing. For example, as we've pointed out before, the biggest net inflow into equity mutual funds came in the first quarter of 2000, just around the time the Nasdaq began its historic decline.

As regular readers know, in addition to hard-asset and inflation-oriented investments, I'm also looking abroad right now. My thesis is that as the U.S. dollar weakens, so will the attractiveness of U.S. assets relative to those in other countries.

Thus far, the theory seems to be working. As I highlighted in last week's column, many foreign stocks, from emerging and industrialized economies alike, have recently outperformed U.S. markets. Yet it's downright impossible to make the argument that the herd, as evidenced by the behavior of most mutual-fund investors, is running wild in foreign names.

Consider some of the statistics complied by the Investment Company Institute, and you'll likely agree. Since 1990, inflows into foreign funds have never come close to those into domestic funds. And of the $2.6 trillion of U.S. assets held in equity funds, only about 15% is pegged to overseas assets.

Trade in the U.S.A.
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Source: The Investment Company Institute 2003 Factbook

Of course, mutual funds are no longer confined to the traditional open-end variety familiar to most investors. Exchange-traded funds, which trade like stocks and are priced throughout the day, have taken off in recent years. Products like Spiders, which track the S&P 500, and Cubes, which follow the Nasdaq 100, are among the most actively traded investments on earth.

Although there are ETFs based on a number of foreign markets, the volume is dwarfed by that of the big domestic funds, even as many international markets outpace those in the U.S.

For example, consider iShares Austria, which we last mentioned more than a year ago. The fund is up almost 35% this year, handily beating the Dow Jones Industrial Average and the S&P 500. Yet the average daily volume is still a meager 14,000 shares, worth about $160,000. Compare that with Spiders, which routinely trade 38 million shares a day, worth nearly $4 billion.

Similarly, iShares Germany, which has gained over 40% this year, trades only 100,000 shares a day, worth about $1.4 million. Compare that with the Cubes, which have also gained more than 40% yet trade 80 million shares a day worth a cool $2.8 billion. The herd might be out there, but it's certainly not in foreign ETFs.

As we like to point out, the only thing that consistently works over time is discipline. Yet because the herd exists and sports such a historically lousy track record it's worth following its tracks. Although there's no sure thing, when a particular trading thesis is working and the herd is nowhere to be found, I know I'm on the right path.

When volume explodes in foreign ETFs and the mutual-fund industry can't roll out new products fast enough, when Business Week does a cover story about how the U.S. market is dead and the smart money is all overseas, and when barbers and cabdrivers begin opining on the economies of Latin America and Eastern Europe perhaps then I'll believe that the herd is rushing into foreign stocks. But we're not there yet. We're not even close.

Jonathan Hoenig is managing member at Capitalistpig Asset Management, a Chicago-based hedge fund. At the time of writing, Hoenig's fund held positions in many of the securities mentioned.