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Great Expectations: What Popular Foreign Funds May Be In For

Investors have flocked to international funds, but have they made good choices?

Bridget B. Hughes, 11/20/2006

Just five years ago, some may have questioned the utility of international funds. After all, U.S. stock funds were soaring to the top of the performance charts in the late 1990s. Then when markets came tumbling down in 2000, international offerings didn't provide all that much ballast. In the relative calm of the past few years, though, many international funds have proved their value, and investors have noticed.

Recent fund flow data, provided by Financial Research Corporation, or FRC, show that investors have been loading up on international funds. As of the end of September 2006, FRC estimates that "International/Global" funds now compose fully 20% of mutual fund assets. Although global funds include U.S. stocks and investors certainly have investments other than mutual funds in their portfolios, it indicates that foreign investments have become a bigger piece of investor portfolios than they have been.

The increase is simple mathematics. First, international funds have performed quite well compared with U.S. stock funds. Over the past one- and three-year periods, every foreign-stock category (with the exception of Japan-stock) has outdone every diversified U.S. stock grouping. Second, investors have been buying foreign offerings in recent years. For 2006 through September, the three largest foreign categories, foreign large-value, foreign large-blend, and foreign large-growth, together took in nearly $70 billion--close to 40% of total year-to-date flows into all mutual funds.

While we're happy to see investors paying more attention to foreign funds, we hope that the motivation behind the interest isn't based on recent performance alone. In fact, we'd encourage investors to temper their expectations of these funds, considering international funds' strength over the past several years relative to U.S. funds. We also encourage investors to be tolerant of any near-term weakness.

Having said that, every fund is different, with its own set of considerations. Below we offer our thoughts on the year's most popular foreign-stock funds. They are listed in order of how much money they've consumed so far this year and represent all nine of the international funds that made FRC's list of the 20 best-selling funds through September 2006.

American Funds Capital World Growth & Income CWGIX
In 2006, this fund has taken in close to $12 billion, bringing its total assets to more than $75 billion currently. Fortunately, the fund's world-stock mandate, which allows it to buy stocks from anywhere around the world, gives it a large investment universe. But we're growing concerned about its size, which could make it tougher to maneuver in order to weather various market conditions--something that the management team has been able to do quite well here. Nonetheless, its broad investment mandate, long-term approach, and superb research and management capabilities give us confidence in this fund over the long haul. It's quite reasonably priced, too.

Bottom Line: A solid pick.

American Funds EuroPacific Growth AEPGX
Like its sibling discussed above, this offering is cheap and boasts the same type of impressive research and portfolio-management backbone. Certainly, its shareholders have been well served. We are more concerned about this foreign large-blend fund's size than we are with Capital World Growth & Income's, however. Its mandate limits its investment universe to just non-U.S. stocks, roughly cutting its opportunities to half that of its world-stock counterpart. Further, its tendency to invest a decent chunk of its portfolio in emerging-markets stocks could hinder it; those markets tend to be less-liquid and more-volatile. That said, it remains a very solid core international offering.

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