Foreign Fund Winners, Losers, and Comebacks

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

Although many international mutual funds were in the red at mid-year, they've made a stunning comeback recently. Here to discuss some of the trends that Morningstar's analyst team is seeing in the world of international mutual funds is Karin Anderson. She is an analyst for Morningstar.

Karin, thanks so much for being here.

Karin Anderson: Thanks for having me.

Benz: So Karin, when we look across International fund performance, you see that most fund categories are solidly in the black year-to-date, but I'm wondering if you can discuss, who the biggest winners have been and where some of the biggest losers have been?

Anderson: Well, one of the key themes for the year was the European debt crisis and what that did to Europe stocks in general. For the first half of year, they were down about 16%, with the worst of the sell-off coming in the spring. When things started to settle down a little bit, and people were perhaps less nervous that there would be sovereign defaults, performance has been bouncing back ever since. So, those stocks are up about 4% for the year-to-date.

So, Europe stocks in general have been the worst performers for the year. On the flip side of the coin some of the better performers have been small-cap stocks. Just as in 2009, they have outperformed their larger cap brethren. And so, small- and mid-cap funds have generally been up in the teens and 20% range.

And then again, like in 2009 emerging-markets stocks are beating developed-markets stocks. This is largely due to what happened with European stocks this year. But the gains haven't been quite as dramatic, but emerging-markets stocks in general are up in the 30% range.

Benz: It's nothing to sneeze at.

Anderson: Very significant.

Benz: Right, right. So, within emerging markets, people think that that category is really on fire right now, in a lot of ways it is, but you have said that even within that category, there have been some really strong performing markets and then areas that haven't performed as well. Let's dig beneath the surface there.

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Anderson: Definitely. The big news item among the developing markets is how well Indian stocks have done this year. They are up about 25% for the year-to-date, which is very good. And some managers are citing that they're maybe paring back a little bit from India, because they're at historically high valuations.

On the other side of the coin, Brazil is another of the major emerging markets countries. It is up only 5% for the year-to-date, so a major cool-off, after 2009's gains, when Brazil stocks were up roughly 125%.

And then with China and Russia, the other two larger countries that are at play, they're in up in the mid-teens this year, which are great gains as well, but you see quite a bit of diversity among that group.

Benz: Okay. So, I'm hoping you can touch at least briefly on Japan, the perennially beleaguered market, again not performing especially well in what has been a very broad international rally.

Anderson: That's right. Japan again has weighed on a lot of funds, many core funds that stick to the MSCI EAFE Index will have a good chunk of assets in Japan. And some managers do believe that there is opportunity to be had it in Japan and have some pretty big stakes there. The problems are, for many managers on the other side, lack of interesting corporate structures, specter of deflation, slow economic growth, aging population, just too many things working against it. So, again Japan hasn't done very well. It's done just slightly better than Europe for the year. But some managers, like I said, do find opportunity there. The managers at Longleaf Partners International have a pretty big stake there, which actually didn't hurt them this year that much because they are focusing more on smaller-cap firms. So I think that managers who have focused on the companies that played to the consumer in Japan have been okay, but overall those with stakes in the larger-cap firms, that's been a bit of a drag for them.

Benz: Okay. Karin, I want to discuss this developed versus developing question, and you all have an interesting view in that you talk to managers who can invest in either developed or developing. What are you hearing from them? Are they tempted to kind of pull back on developing markets exposure after the very strong runup that we've seen over the past few years? How do they stand on that question?

Anderson: We're definitely hearing a lot of that. I heard from Brent Lynn of Janus Overseas. It's a foreign large-growth fund

Benz: It's one of the great performers as well.

Anderson: Great performer, does very well in rallies. The emerging-markets stake there has been very large for quite a while, for several years, and he has been paring that back on valuation concerns. It's still a significant part of the portfolio, but it's just caution on his part with regard to specific valuations. He cited being a little bit more interested in some of the opportunities in Europe given the sell-off earlier in the year.

So that's definitely happening, and then you have other mangers that are in the camp of, I don't want to be in emerging markets. I want to own the companies that have substantial revenues in emerging markets; that's also a quite common, too. And managers that have the leeway to go anywhere have been citing just far more attractive valuations among the developed markets companies that are selling to the emerging markets. One stock that has come up a couple items is Avon, with has a lot of sales in South America versus Natura Cosmetics of Brazil, so some managers are really saying that Avon looks like a much better buy at this point.

Benz: Karin, the team in Morningstar recently launched a China category. Can you discuss the thought process that went into launching the country-specific category there.

Anderson: No problem. Now, there are about 25 funds in that newer category. So we felt like it was definitely a time to have a specific category carved out for these funds, and they are going to have stocks domiciled in China, Hong Kong, and Taiwan. This is going to be a very good thing for tracking the performance of these particular funds before they were in the Pacific Asia, ex-Japan category, which as much more regionally diverse. The rationale for launching it is, there are 25 funds, we feel like that that's a significant amount, and for a single-country-focused fund, there are enough there to work with, whereas there are probably only a couple Brazil focused funds, maybe a fewer than 10 India-focused funds. So we just thought this was the right time.

Benz: Okay. Well, thanks, Karin always great to hear your insights. Thanks for being here.

Anderson: Thank you.

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