A Compelling, Just-Reopened International-Stock Fund

The following is our latest Fund Analyst Report for FMI International FMIJX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

FMI International’s capacity-conscious and cautious, but effective, strategy merits a Morningstar Analyst Rating of Silver.

Prior to reopening in April 2018, the fund had been closed to new investors since May 2017. FMI keeps tabs on liquidity in the fund’s 25- to 40-stock portfolio and doesn’t hesitate to close it to new investors to preserve its flexibility to invest in stocks with at least a $4 billion market cap. A hefty weighting at the lower end of the market-spectrum isn’t inevitable here, but the portfolio’s 17.8% combined small- and mid-cap stake at year-end 2017 ranked in the foreign large-blend Morningstar Category’s top third.

The fund uses the same risk-averse, value-oriented, and team-based approach as its domestic siblings, but one adapted to international investing. Positions in non-U.S. developed-markets firms take up the bulk of the fund’s assets and management considers companies’ domiciles as well as revenue sources in building them. IT consulting and services provider

Concerns about transparency and accounting have kept the fund from buying mainland Chinese as well as Russian companies, but it hasn’t avoided emerging-markets stocks entirely. Counting South Korean and Taiwanese firms, the fund had a typical 9.4% emerging-markets stake in late 2017. It included a top-five position in Samsung Electronics' preferred shares, which management thinks are a bargain given the firm’s robust semiconductor business.

The fund's policy of hedging foreign-currency exposure means it seldom moves in lockstep with its category rivals, nearly all of whom are unhedged. Indeed, currency fluctuations can have a big impact on category rankings in any given year. A plummeting U.S. dollar in 2017 led the fund to trail 99% of its peers. The fund, though, modestly lagged the MSCI EAFE 100% Hedged Index that year and its long-term risk-adjusted results remain superior to the benchmark’s.

Process Pillar: Positive | Alec Lucas, Ph.D. 04/11/2018 The fund receives a Positive Process Pillar rating for its use of FMI's firmwide collaborative, high-conviction approach. Focused on non-U.S. stocks with market caps above $4 billion, it looks for companies with durable business models and strong management that generate superior profitability through a full economic cycle.

The fund’s policy of hedging foreign-currency exposure highlights management’s focus on underlying business fundamentals. In consultation with CIO Patrick English and research director Jonathan Bloom, members of FMI’s portfolio management committee appraise potential investments based on what it would cost to acquire them outright. They pay close attention to historical valuations versus peers’ and the MSCI EAFE Index, but only buy stocks trading at a minimum one third discount to their estimated intrinsic worth over a five-year holding period. Such bargains tend to occur because of controversy, uncertainty, or short-term headwinds. The team typically shies away from firms with high debt levels, but will buy those whose cash flows are steady enough to support their leverage. The team trims or sells stocks as they become fully valued. Meanwhile, steep share price drops spur reevaluation. If the stock presents an even greater bargain without undue risk, management buys more; if something is amiss, they sell.

Annual turnover has ranged from 9% to 26%, well below most foreign large-blend peers’.

The fund holds a focused portfolio of 25 to 40 stocks because few companies meet management’s stringent investment criteria. The team, though, keeps a watchlist of good businesses so they’re ready to act if shares dip to bargain levels. Cash is a residual of the investment process. It has been above 15% since late 2016.

Individual position sizes typically range from 1% to 6% of assets based on valuation and fit within the portfolio, and management considers companies’ domiciles as well as revenue sources in building them. IT consulting and services provider Accenture, the fund’s top holding since year-end 2014, trades on the New York Stock Exchange but is headquartered in Ireland and more than half of its revenue comes from outside the United States.

Concerns about transparency and accounting have kept the fund from buying mainland Chinese as well as Russian companies, but it hasn’t avoided emerging-markets stocks entirely. Including South Korea and Taiwan, emerging-markets exposure peaked at 11% of assets in March 2014, but has stayed in the single digits since.

Sector over- and underweightings versus the MSCI EAFE Index can be massive. The fund tends to favor industrials stocks because it finds bargains among this sector’s often-cyclical businesses. At year-end 2017, the fund’s 26% industrials stake was 11 percentage points more than the index's.

Performance Pillar: Positive | Alec Lucas, Ph.D. 04/11/2018 This U.S.-dollar-hedged fund receives a Positive Performance Pillar rating for its strong record since its 2011 start. Through March 2018, the fund's 9.4% annualized gain beat the MSCI EAFE 100% Hedged Index by 1.5 percentage points with about one fourth less volatility.

Superior downside protection during major market plunges helped the fund outpace the index. Even considering its cash buffer, the portfolio proved resilient in 2011 and 2015-16. In the latter period, for example, the fund lost 13% peak to trough versus the index’s 22.8% drop.

The fund seldom moves in lock step with its foreign large-blend category peers, nearly all of whom are unhedged. Indeed, currency fluctuations can have a big impact on rankings in any given year. When the U.S. dollar shot up against a basket of major currencies in 2014, the fund’s 4.6% gain beat 98% of its peers but fell shy of the index by a percentage point. In 2017, the fund’s 15.5% gain lagged its hedged benchmark by 1.4 percentage points, but a plummeting U.S. dollar led the fund to trail 99% of its peers.

Currency effects have tended to even out over the very long term, but they can persist over a 10-year period. From its 1993 inception through March 2018, the MSCI EAFE 100% Hedged Index beat its unhedged counterpart by 22 annualized basis points with less volatility, but between August 2001 and July 2011 it lagged by 4.5 annualized percentage points.

People Pillar: Positive | Alec Lucas, Ph.D. 04/11/2018 The fund's stable 10-person management team has a healthy mix of seasoned and more junior members who collaborate effectively and invest alongside shareholders. It receives a Positive People Pillar rating.

CIO Patrick English, who joined FMI in 1986 from Dodge and Cox, helped shape the firm’s similar committee-based approach. English and research director Jonathan Bloom vet each team member’s investment ideas for this fund, and domestic siblings

The team boasts ample experience as four members have been in the industry more than 20 years. Yet, newer additions can still make major contributions and earn more responsibility. Bloom, for example, joined FMI in March 2010 and helped prepare FMI International for its launch at the end of that year. He became research director of international equities in late 2015 and then domestic stocks, too, in 2018.

Each manager owns all three FMI funds. English invests more than $3 million across the lineup and three others over $1 million apiece.

Parent Pillar: Positive | Alec Lucas, Ph.D. 03/23/2018 Independent, Milwaukee-based Fiduciary Management, Inc. is an industry standout and earns a Positive Parent rating. The firm has built up $26.1 billion in assets under management, as of year-end 2017, through prioritizing strong long-term results in its three-equity-fund lineup. The firm keeps close tabs on their capacity and has not been shy about closing them to new investors. With FMI International reopening in April 2018, all three funds will be simultaneously available to new investors for the first time.

The FMI lineup’s accessibility comes amid persistent outflows, but the firm remains in excellent financial health. It has no debt and could manage about a fifth of its current assets without making cutbacks. FMI’s robust balance sheet helps management stay focused on investing rather than asset maintenance during market slumps. While running its business conservatively and limiting asset size keep its funds from competing on cost with passive rivals, FMI has cut prices to keep them in line with most active peers’.

An orderly transition will keep FMI’s future in the hands of its investment personnel. Co-founder Ted Kellner, who retired in mid-2017, is reducing his ownership stake to allow them a greater share. Under CEO Patrick English and research director Jonathan Bloom, FMI’s team is poised to build on its past success.

Price Pillar: Positive | Alec Lucas, Ph.D. 04/11/2018 Competitive fees earn the fund a Positive Price Pillar rating. The retail shares' 0.91% expense ratio and the institutional shares' 0.77% both rank in the second-cheapest quintile of similarly distributed foreign large-cap peers. Trading costs as a percentage of net assets are also better than most. In fiscal 2017, brokerage fees of 0.04% of average net assets fell below the 0.06% category median.

Fee breakpoints help keep a lid on costs. The fund charges 0.75% on the first $2.5 billion in assets, 0.70% for the next $2.5 billion, 0.65% for the next $5 billion, and 0.60% for assets beyond $10 billion.

Capital gains distributions each year since 2013 have hurt investors in taxable accounts. In 2017, the fund distributed a capital gain of 1.35% of net asset value in December.