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Hunting Down European Debt-Dodgers

This screen identifies good foreign funds that take a different path.

Greg Carlson, 09/13/2010

Managers of core foreign funds face an interesting choice these days. Europe has been beset by government-debt woes. Greece may be in the worst shape, but other countries in the region are struggling as well. Further, many observers were already predicting very sluggish economic growth for the Continent before the debt crisis deepened. And yet at 60%, Europe is a huge part of the MSCI EAFE Index, the benchmark for most core foreign funds. Many fund managers may find it difficult to choose between the risks of investing the lion's share of their portfolios in European firms and deviating significantly from the index. At many shops, doing the latter can be a risky career move if it backfires.

We set out to identify managers of large-cap foreign funds who are treading relatively lightly in Europe and have been successful in the past while not aping the index or their peers.

Using the screening tools in Morningstar Principia and Morningstar Advisor Workstation, we searched for distinct funds within the foreign large-blend, foreign large-growth, and foreign large-value categories that are open to new investors, covered by Morningstar's fund analysts, and can be purchased with an initial outlay of $10,000 or less (making them accessible to a sizable number of investors).

Special Criteria = Distinct Portfolios Only
And (Morningstar Category = Foreign Large Value
Or Morningstar Category = Foreign Large Blend
Or Morningstar Category = Foreign Large Growth)
And Purchase Constraints = Closed-New Investment
And Min. Initial Purchase <= 10,000
And Analysis not= NA

We also set the screens to home in on funds with a smaller Europe weighting than the MSCI EAFE's and whose returns have been relatively less correlated to the index.

For the latter measure, we wanted funds that had R-squareds (a measure of correlation) of less than 94 over the trailing three years. That figure still looks fairly high on a long-term basis, but correlations have been especially tight over the past three years--setting the bar at lower than 94 eliminates more than 80% of all foreign large-cap funds and zeroes in on funds that have strayed from the pack.

And Super Region % Greater Europe < 60
And R2 3 Yr < 94

Finally, we wanted funds with proven, experienced managers and modest costs. So, we searched for funds where the managers have been on board for at least five years, have beaten 75% of their category rivals over that span, and have lower expense ratios than their typical peer's.

And % Rank Cat % Yr<= 25
And Morningstar Tenure (Longest) >= 5
And Audited Expense Ratio <= 1.5

Three funds passed the screen as of June 28, 2010.

Columbia International Value NIVLX
Columbia International Value has long taken a different path. Subadvisor Brandes Investment Partners, which has run the fund since its 1995 inception, is willing to take big bets against the benchmark. For example, it has long held an outsized stake in Japan--one reason for its smaller-than-the-index Europe weighting. But it typically makes these bets in the name of reducing downside risk. That bet, along with a recent emphasis on steadier sectors such as health care, helped the fund hold up better than 85% of its foreign large-value peers in 2008's sharp decline.

Masters' Select International MSILX
Masters' Select International spreads its assets among six accomplished, distinctive managers. Their styles run the gamut from aggressive growth (such as James Gendelman of Harbor International Growth HIIGX) to deep value (Amit Wadhwaney of Third Avenue International Value TAVIX). Each contributes just eight to 15 stocks to the portfolio. The fund tends to hold more small- and mid-cap firms and a bigger emerging-markets stake than do its foreign large-blend rivals. Those traits are a product of its relatively concentrated portfolio and fund overseer Litman/Gregory's taste for subadvisors who aren't afraid to blaze their own trails.

Janus Overseas JAOSX
Manager Brent Lynn has done a superb job. However, investors should be aware of its bold profile, and they should weight it in their portfolios according to their risk tolerance. Lynn has been a big believer in the growth potential of developing countries, and that's been reflected in the fund's portfolio since he took sole control in June 2003. That bet led to a brutal loss in the October 2007-March 2009 bear market, but Lynn stuck to his guns and has since made back the ground the fund lost.

Greg Carlson is mutual fund analyst with Morningstar.

Greg Carlson is a fund analyst with Morningstar.

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