Foreign Affairs

I'm not arguing for foreign stocks for the reasons financial planners and mutual-fund companies usually do. They usually make the case for buying foreign stocks by stressing the benefits of diversification. Indeed, many world markets are uncorrelated to U.S. stocks, meaning that they do have a tendency to zig when the U.S. zags.

But there's a fine line between diversification and just wasting money. Too often people buy weak and out-of-favor stocks simply in the name of diversification. And after a few months' time, they usually end up selling with a loss. Sure, they diversified, but they did it in the wrong kind of stock.

You want to buy strong stocks, and that, along with a major lack of public participation, is a key reason I'm aggressively buying non-U.S. companies these days.

Most investors avoid foreign stocks because of something that can best be described as home bias, or the tendency for people to favor investments from their native countries or states. There's something undeniably comfortable about buying General Electric (GE), IBM (IBM) or any of the other well-known brands that dominate most people's portfolios. After all, we know these companies. They have hundreds of thousands of investors and have been around for many years.

Because foreign stocks are, by definition, foreign, we tend to see them as being more dangerous than stocks we think we know more about. How secure would you feel knowing that your fund manager was putting your paycheck on Yapi ve Kredi Bankasi or Vestel Elek Sanayi Ticaret, two of the stocks that make up the closed-end Turkish Investment Fund (TKF)? And although it's up 60% in the last six months, I don't hear Netas Telekomunik (another of the fund's largest holdings) being touted on CNBC as the next Cisco (CSCO) or Sun Microsystems (SUNW). If you ask me, it's an ignorant oversight.

As we've pointed out before, many of the best trades come in areas that are perceived as being highly risky. Sure, there are unique aspects of investing overseas, but avoiding all foreign stocks simply because they're "risky" is the investing equivalent of racial profiling. It's also an attitude that will cost you money, considering that, as we wrote a few months back, a "good bet" isn't just one that pays off, but pays off with attractively large odds.

In today's environment, many foreign stocks now present this unique opportunity. They're at a junction of being underowned, underfollowed and outperforming all at the same time. And their exceptional performance is the real reason to consider looking at some foreign stocks. Right now, they're good investments — for the long haul perhaps, but for the short run most certainly.

Focusing on foreign stocks has recently become trendy among analysts. Merrill Lynch has been bullish on Japan as of late, and J.P. Morgan has been touting Europe. And although both regions offer plenty of buys (we did some table-pounding on Japan ourselves a full three months before Merrill), I believe the real performance will be found in the more speculative emerging markets within Europe and Southeast Asia. In addition, I'm of the mind that Mexican, Australian and Russian stocks should also be considered at current levels. Australian stocks, not too far off their all-time highs, have benefited from a rise in commodity prices, while emerging markets, as we pointed out a few weeks back, have been on a tear. The Bank of New York ADR Index of emerging-market stocks is up over 6% year-to-date, with many subindexes doing even better.

For those investors too uncomfortable or undercapitalized to buy individual foreign stocks in the form of American depositary receipts (ADRs), there are a myriad of good exchange-traded funds to consider, including iShares MSCI Mexico (Free) Index Fund (EWW) and iShares MSCI Australia Index Fund (EWA), closed-end funds like Templeton Russia Fund (TRF) and traditional mutual funds like Frank Russell Emerging Markets (REMSX) and SSgA Emerging Markets (SSEMX).

Despite the market's recent rout, U.S. stocks still have good five- and 10-year performance records. And because most investments decision are incorrectly made by focusing on long-term results, it's my belief that over the near term, most investors will continue to focus on U.S. stocks. That creates a unique opportunity for those of us with a more worldly view to load up on some once-in-a-lifetime bargains.

Jonathan Hoenig is portfolio manager at Capitalistpig Asset Management, a Chicago-based hedge fund. Hoenig's fund has positions in many of the securities mentioned in the article.