Core Foreign Funds That Aren't Betting Big on Europe

Managers of core foreign funds face an interesting choice these days. Europe has been beset by government debt woes; while Greece may be in the worst shape, others countries in the region are struggling, as well. Furthermore, many observers were already predicting very sluggish economic growth for the continent before the debt crisis deepened. And yet Europe is a huge part (60%) of the MSCI EAFE Index, the benchmark for most core foreign funds. Many skippers may find it difficult to choose between the risks of investing the lion's share of their portfolios in Europe-based firms and deviating significantly from the index. Doing the latter can, at many shops, mean taking on career risk for these managers if their moves backfire.

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 Premium Fund Screener tool on Morningstar.com, 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. We also set the screens to home in on funds with a smaller Europe weighting than the MSCI EAFE's 60% 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. Finally, we searched for funds where the managers have been on board for at least five years that have beaten out 75% of their category rivals over that span, and have lower expense ratios than their typical peers.

Here are the results as of June 14, 2010. Click here to run the screen yourself.

 Columbia International Value 

 Invesco International Growth (AIIEX)

 Manning & Napier World Opportunities 

 Masters' Select International (MSILX)

One fund that was excluded because its distinct portfolio is closed to new investors has another share class that is open:  Janus Overseas (JAOSX)

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 Europe weighting--but typically does so 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. True, it has occasionally misfired; its stakes in banks and telecom firms led to a poor showing in 2002's decline. But it's been quite successful over the long haul and is backed by a deep, veteran team.

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 ). 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. On a similar note, the fund's stake in the U.K. and Western Europe was recently a rather modest 48%. This profile can make for streaky relative returns at times, but the fund's long-term record is excellent. And its portfolio is wide-ranging enough to make it a stand-alone foreign holding.

Although we took pains to include Janus Overseas on this list because manager Brent Lynn has done a superb job, investors should be aware of its bold profile and weight it in their portfolios according to their own 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 (and then some) on its typical foreign large-growth peer. This is no one-trick pony; Lynn has successfully invested in a smattering of U.S. firms, for example, that derive a great deal of their revenues from elsewhere. But the fund's recent stake in Europe was a minuscule 18%, which could bite back if the problems there don't turn out to be as bad as expected. Furthermore, the fund's returns have been quite volatile over time. Nevertheless, it's an intriguing holding.

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