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Newly Issued Ratings for 3 Foreign Funds

Fri, 2 Aug 2013

A big price tag keeps one fund in Neutral territory despite its pedigree, while two small-cap funds get Silver ratings.

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Video Transcript

Christine Benz: Hi. I'm Christine Benz for Morningstar.com.

Morningstar's analysts have issued new ratings on three international funds. Joining me to discuss them is Russ Kinnel, director of fund research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, let's start with Longleaf Partners Global. This is a fund from a family that we like to some extent, especially for their domestic-stock fund Longleaf Partners. Let's talk about why this one just rates a Neutral right out of the box.

Kinnel: It's got a great pedigree in Mason Hawkins and Staley Cates, and they're investing the Longleaf way, and they are borrowing from foreign and domestic ideas. So all of that's great, but the fund is charging 1.65% in expenses, which is way above what you pay for the international or domestic funds. So there are some good ingredients here, but at that fee level, it's a lot less attractive.

Benz: So, you think for someone who wants to tap into Longleaf's abilities--and we do think it's a good firm from the standpoint of people and parent and process--you think you're better off maybe buying the international fund, buying Longleaf Partners, and then adjusting your own allocations accordingly?

Kinnel: That's right. This fund is actually not going to be exactly the same as those other two funds, but it's borrowing the stocks from those same portfolios, and it's not going to shift the allocation very much. So, you're much better off, I think, buying those funds directly. We think the underlying funds are good. Obviously, domestically they've had some challenges, performance has slacked off a little lately, but it still has good long-term performance. But I don't see why you'd want to pay 1.65% versus the lower fees you'd pay for other two funds.

Benz: Let's look at a couple of small-cap international funds that have recently gotten ratings. Let's start with DFA International Small Company. It's a fund we've had under coverage for a number of years. We only recently gave it a rating, and it came in at Silver. Let's talk about what that fund is doing right, as well as why it doesn't earn a Gold rating at this point.

Kinnel: Small caps are in DFA's wheelhouse. What they do is, they take a passive approach to investing. It's not quite an index, because they'll essentially have a portfolio that's like an index, but they'll give themselves flexibility to add stocks here or there based on what the market is trading. So if people really want to buy a stock over here, they'll sell. If they're really eager to sell, they'll buy. That's a way to reduce trading costs, which is really a big deal with small caps, particularly international small caps. So DFA has got a very good mousetrap for investing in passive small-caps internationally.

The downside, though: It is relatively volatile. At 55 basis points, it's pretty cheap, but it's not as cheap as, say, a domestic small-cap fund, [which] might only charge 20 basis points or 15 basis points. So very good, but just enough to take it down a notch.

Benz: One question that investors sometimes have regarding DFA funds is that, they might look at the lineup, find funds that they think are attractive, and realize, well, if I'm a do-it-yourself individual investor, these funds can be very difficult to buy. Has that changed somewhat over the years? Are they easier to buy now? Or are they still available only through DFA-only advisors?

Kinnel: More advisors can use them. They're in more platforms. However, if you're a regular no-load investor investing through a big platform like Fidelity or Schwab, you probably don't have access. So I hate to be a tease, but it's more available, and they are great funds if you can access them, but they're not available for everyone.

Benz: And DFA is certainly getting more prominence on 401(k) platforms as well?

Kinnel: Yes, they are.

Benz: Another fund in a similar vein is Vanguard FTSE All World ex-US Small Cap; also a small-cap international fund. Let's talk about it, because it too comes in at Silver, and maybe you can help comparison-shop these two and talk about what the salient differences are.

Kinnel: It's really worth looking at the two together, because they are the tightest competitors for [each other]. They're well-run, low-cost foreign small-cap index funds. The Vanguard fund charges 45 basis points, so it's 10 basis points cheaper than the DFA fund, and it's got a good index. It's a low-turnover index, so we expect it will do well. However, it's only got about a three-year track record. So you don't have as long a track record.

Interestingly, we looked at how the DFA fund has done over the long haul against the index that Vanguard is tracking, and the DFA fund has actually beaten it. So that's a positive. But really it's a close call, because I think DFA's strategy for managing small-cap trading is probably a little better than Vanguard's. So maybe I'll give a slight edge to DFA, but it's really a close call.

Benz: Vanguard has the edge in terms of raw costs anyway.

Kinnel: Yes, and an even better deal is if you go with the ETF, which is 25 basis points. So, unfortunately, they don't have an Admiral share class yet, but they do have the ETF at an even lower price point.

Benz: One follow-up question for people who are Vanguard-only investors: There is also an actively managed small-cap fund, International Explorer. I noted that we actually have that fund at Neutral currently. Now we've got the index fund at Silver. I guess that means that we think for people who want that international small-cap exposure, they should look at the index product.

Kinnel: The International Explorer [Fund] has been a little disappointing, and we've lowered our ratings to reflect that. So, I think the Vanguard index fund is probably a little better option, especially in the ETF, which is significantly cheaper.

Benz: But you note that the International Explorer is actually cheaper than the index traditional mutual fund.

Kinnel: That's right. The International Explorer is 43 basis points versus 45 for the Investor share class of the index fund.

Benz: But in both respects, probably well below their category average.

Kinnel: That's right. Both are very cheap compared to your typical foreign small-cap fund.

Benz: Russ, great summary. Thank you so much for being here.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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