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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.

Defense was not good offense in 2016. Virtus Emerging Markets Opportunities HEMZX, which has a Bronze rating and has been known for a more cautious approach to stock-picking under its current and former managers--Matt Benkendorf and Rajiv Jain, respectively--sat at the back of the pack with a 1% gain for the year through Dec. 29, trailing nearly 90% of its peers. A big stake in consumer defensive names, including some global brands based in developed markets but boasting a lot of emerging-markets revenue, such as SAB Miller, hindered the fund.

Global funds with above-average emerging-markets exposure did well. Fearless picks like Brazilian oil giant Petrobras PBR, whose stock had fallen in seven of the last 10 calendar years, boosted the year-to-date results of Gold-rated Dodge & Cox Global Stock DODWX. The value fund has about twice its MSCI ACWI benchmark's helping of emerging-markets stocks. That wasn't the only formula for success for world-stock funds, though. Silver-rated Franklin Mutual Global Discovery MDISX did well with energy holdings, such as Royal Dutch Shell RDS.AConsol Energy CNXKinder Morgan KMI, and Marathon Oil MRO, rather than emerging markets. Meanwhile, Silver-rated Oppenheimer Global OPPAX and Neutral-rated BlackRock Long-Horizon Equity MDEGX were among the worst-ranking global funds. Each had below-average emerging-markets and energy stakes.

More-diversified international funds were a mixed bag. Foreign small/mid-value and foreign large-value funds performed well. Foreign small/mid-blend and foreign large blend were flat on average. The foreign large-growth and small/mid-growth categories lost money.

Fortune Favors the Bold
Boldness paid off in these categories as well. Unrated Kopernik Global All-Cap KGGAXwas the best foreign small/mid fund with a 47% gain through Dec. 29, driven by a more than 30% emerging-markets stake. Gold-rated Dodge & Cox International Stock DODFX, which like its global sibling carried a larger-than-average emerging-markets stake--including Petrobras, also turned in strong numbers.

Winning foreign-stock funds did not have to be so aggressive, but they did have to be willing to depart from the crowd. The Silver-rated and developing-economy-light FMI International FMIJX was among the best foreign large-blend funds with or without emerging-markets exposure. Industrials picks, such as Rolls-Royce Holdings and Smiths Group, fueled its returns.

Growth suffered, and Artisan's Mark Yockey and team were the poster children. Yockey's flexible approach that tries to combine aggressive, sustainable, and turnaround growth plays in one portfolio can produce an eclectic fund that sometimes looks out of step. This year has been one of those times. All four of his team's funds--Bronze-rated Artisan Global Equity ARTHX, unrated Artisan Global Small Cap ARTWX, Silver-rated Artisan International ARTIX, and Gold-rated Artisan International Small Cap ARTJX--ranked in or near the bottom 10% of their respective categories for the year through Dec. 29. A lack of energy and emerging-markets exposure hampered the funds, but so did a variety of errant picks from other regions, such as Japan Tobacco and Ginko International.

Neutral-rated aggressive-growth fund Wasatch International Opportunities WAIOX was a bright spot in the foreign small/mid-growth category. The fund's massive emerging-markets position (33% of assets) and outsize helping of consumer cyclical stocks, such as Australia's Webjet, kept it in positive territory.

Expect the Unexpected
Let this year serve as a reminder not to overreact to either short-term bouts of harrowing performance or tumultuous world events. Those who pared international and emerging-markets exposure after 2015's poor results have missed this year's gains. Those who sold after Brexit and the stunning U.S. election have been unpleasantly surprised by global equity markets' resilience. As always, strive to understand the forces that are affecting a balanced, long-term investment plan, but stick to the plan.


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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