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International-Stock Funds Conquer Concerns in 2016

Most categories managed to climb a wall of worry as emerging markets and energy revived.

Dan Culloton, 01/03/2017

This year was a mirror image of 2015 for non-U.S. stock funds in terms of performance, according to preliminary returns. The average international-equity fund lost 3.4% in 2015 but eked out a 4.0% gain in 2016 through Dec. 29, despite a host of concerns. Those worries included terrorism, political turmoil in both the Western and Eastern hemispheres, and currency volatility.

Wall of Worry
Broadly, a rebound in Latin American markets, the United Kingdom's vote to leave the European Union in June, the surprise election of Donald Trump as the U.S. president, scattered acts of terrorism across the globe, and the strengthening dollar were all among the bricks in the wall of worry that most international-equity Morningstar Categories managed to climb in 2016.

The year began with a severe global equity market sell-off, then started a sustained rebound in mid-February. By the end of December, more than half of Morningstar's non-U.S. equity categories were on pace to post gains.

As the year approached its denouement, value was beating growth, small was doing better than large, and emerging markets better than developed. On a more granular level, funds owning a lot of European and Chinese stocks got bruised, while those with exposure to South America and/or Russia got a boost. 

Currency effects--as always--played a role in international-fund returns. Most U.S.-based funds are fully or almost fully unhedged, which means that declines in foreign currencies versus the U.S. dollar damp their returns, because those returns must be translated into dollars. Tweedy, Browne Global Value TBGVX, which hedges its currency exposure back into dollars, exemplifies this. The hedged version of this fund, which has a Morningstar Analyst Rating of Silver, gained more than 5% through Dec. 29, but the unhedged version of its portfolio, Tweedy, Browne Global Value Fund II--Currency Unhedged TBCUX, rose less than 2%.

Resurgent Emerging Markets
That's the broad sweep. A closer look shows wider divergence among funds and categories.

Latin America stock, diversified emerging markets, and world stock were among the best performing peer groups. Funds such as the unrated Fidelity Latin America FLATX, which posted a 20.5% gain through Dec. 29, were largely driven by Brazilian equities, whose markets rallied despite a continuing business and political scandal that led to the impeachment of President Dilma Rousseff in August. Energy, gold mining, and commodities-related equities also rallied and fueled returns for some of the better-performing international funds.

Many of the same trends drove performance in broader categories. Diversified emerging-markets funds with large weightings in Latin America did well, and global-stock and diversified international-stock funds that leaned toward emerging markets also ranked highly. Lazard Emerging Markets Equity LZEMX, which has an Analyst Rating of Silver, boasted a larger-than-average stake in Brazil and a smaller-than-average China stake. Exposure to Russian stocks, which also regained ground in 2016 with energy prices, also boosted Lazard Emerging Markets Equity and other funds. Bronze-rated DFA Emerging Markets Value DFEVX, which systematically leans toward smaller, more profitable stocks with lower valuations--including some basic-materials companies whose shares did well in 2016--and Silver-rated Invesco Developing Markets GTDDX, which has roared back from a weak 2015 with its Brazilian and Russian stock picks in 2016, each rose more than 20% through Dec. 29.

Dan Culloton is an associate director of fund analysis for Morningstar and editor of Morningstar's Vanguard Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family. Click here for a free issue of the Vanguard Fund Family Report.

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