Use this screen to find focused funds with stellar risk/reward profiles.
This article first appeared in the April/May 2011 issue of Morningstar Advisor magazine. Get your free subscription today!
Foreign equity funds don't tend to be as concentrated as their domestic counterparts. To illustrate, the median number of holdings for foreign large-cap funds clocked in at 115, which amounted to 51% more stocks than are typically found in a domestic-stock fund. As far as foreign core funds go, it's fair to say that even those with 50 to 70 holdings are on the concentrated side.
Although such funds aren't spreading risk across hundreds of tiny positions, that does not mean they are doomed to deliver a bumpier ride. This Morningstar Principia screen reveals some successful concentrated funds that have kept a lid on risk with a combination of in-depth stock research, deft security selection, and valuation discipline.
Special Criteria = Distinct Portfolios Only
And ( Morningstar category = Foreign Large Value
Or Morningstar category = Foreign Large Blend
Or Morningstar categroy = Foreign Large Growth )
And Total No. of Holdings < 80
And Purchase Contraints not= Closed-New Investment
And Analysis not= NA
To start, cast the net for all foreign large-cap funds that have 80 holdings or fewer. Then narrow the field to funds that are followed by Morningstar analysts.
And Manager Tenure > 10
And % Rank Cat 10 Yr < 25
Next, make sure at least one of the managers has been running the fund for 10 years or more. (In addition to helping find proven managers, this helps ensure that the core strategy has been consistent.) And set the screen to pull funds that have landed in the top quartile of their respective categories during the past 10 years.
And ( Morningstar Risk = Average
Or Morningstar Risk = Below Average
Or Morningstar Risk = Low )
Last, set Morningstar Risk to Average or better to find the funds that have the best risk/ reward profiles.
We performed this screen in Morningstar Principia. As of Feb. 24, here are some of the resulting funds:
Longleaf Partners International
Talk about focused. Longleaf Partners International has had a compact portfolio of fewer than 30 names for years. Managers Mason Hawkins and Staley Cates of Southeastern Asset Management are hardcore value investors, looking for firms that are trading at 40% discounts or more to their intrinsic value estimates. But they aren't afraid to go after more cyclical stocks that many value hounds wouldn't touch with a stick. They pay no heed to indexes, so this portfolio typically has a unique look in terms of its industry and regional weightings. Their low-turnover, valuation-sensitive approach has led to some bottom-decile showings in more exuberant markets, but it has held up particularly well in downdrafts, which has contributed to its great risk/reward profile.
Manning & Napier World Opportunities
During the past decade, the management team behind Manning & Napier World Opportunities has steered it to success without excessive turbulence. In fact, it suffered 15% less in down periods than the MSCI EAFE Index while delivering just as much in up periods. The managers have the flexibility to hunt across the market-cap spectrum, and they scoop up stocks that they believe are trading at more than a 25% discount to fair value. The portfolio isn't as concentrated as it was a decade ago because of a spike in inflows in recent years, but they've shown that they can still pick plenty of winners in a portfolio of 60 to 70 stocks.
The fund's all-cap purview means portfolio- style shifts are inevitable. Small-cap stocks soaked up nearly a third of assets here in 2004; today they make up just more than 2%. Similarly, the fund's emerging-markets exposure, currently just 7%, has been 3 times as high in the past. An investor-friendly culture, solid process, and strong record make this fund a great core holding.
MFS Instl International Equity
It's been steady as she goes at MFS Institutional International Equity during the past 10 years. Manager Marcus Smith, who is the fund's longest-tenured comanager, has done a fine job running a portfolio of roughly 55 to 75 names. And he uses the same low-turnover approach at USAA International
Thornburg International Value
This fund has also provided fundholders with a remarkably smooth ride. And like the MFS fund, it tends to have its best relative showings in down markets. Longtime manager Bill Fries and comanagers Wendy Trevisani and Lei Wang scout out an eclectic mix of stocks for this portfolio. These include financially sound firms selling below their earnings power or net assets, rapidly growing companies that are gaining share within their industries, and blue-chip growth stocks trading at a discount. Their go-anywhere approach means that the portfolio of around 60 stocks often has distinctive sector and country weightings, including a relatively large stake in emerging- markets stocks.
Karin Anderson is a mutual fund analyst with Morningstar..