Foreign Index Beaters

In last week's Five-Star Investor, we launched a series on mutual funds that have beaten their respective indexes over the medium term (five years) and long term (10 years). Our first installment looked at domestic mid-cap funds that outpaced the Russell Midcap Index. This week we turn our sights overseas to look at foreign large-cap funds that have outperformed.

Benchmarking foreign funds can be tricky in that it requires not just consideration of market cap and investing style allocation, but market type, as well. After all, whether a company hails from a developed or emerging market is not an issue one has to deal with when benchmarking domestic stock funds. The issue of benchmarking foreign stock funds has been in the news lately with Vanguard's announcement that it is switching benchmarks for 22 of its funds from MSCI indexes to indexes from FTSE and CRSP. You can see an interview with Vanguard senior exchange-traded fund strategist Joel Dickson about these changes here.

For this week's exercise, we decided to focus on foreign large-cap funds, which typically invest in both developed and emerging markets. Since our Premium Fund Screener tool doesn't allow for benchmarking against a broad foreign index that includes both developed and emerging markets, we decided to use a proxy that does include both kinds of markets, in this case the Vanguard Total International Stock Index (VGTSX) fund, which tracks the MSCI All Country World ex-USA Investable Market Index (but which will transition to the FTSE Global All Cap ex-U.S. Index). The fund currently holds about 23% of its portfolio in emerging markets, according to Vanguard's website. For our purposes, that makes it a better benchmark than, say, the MSCI EAFE index of developed-markets foreign stocks.

Similar to last week, we began by screening for all funds in our chosen category (so foreign large-growth, foreign large-value, and foreign large-blend funds), eliminating index funds to ensure we were left only with active managers. We also applied the distinct portfolio screen to eliminate multiple share classes of the same fund and added a screen to ensure that only funds with track records of at least 10 years were included. Out of this group, we screened on those that beat our foreign large-cap index proxy fund during five- and 10-year periods to identify consistent performance over the medium and long term. Our proxy, Vanguard Total International Stock Index, lost 4.7% annually during the trailing five-year period and gained 9.9% during the trailing 10 years.

Out of the 198 actively managed foreign large-cap funds in Morningstar's database that have been around for at least a decade, fewer than one fourth beat the Vanguard fund proxy in both time frames. (This exercise does not include funds that no longer exist, so it's possible this percentage would have been even lower if those were included.)

To identify some of these index-beating foreign large-cap funds that are available to new investors, we then screened out institutional share classes and funds that are currently closed. Finally, we wanted funds vetted by Morningstar's fund analyst team, so we screened on those with Morningstar Analyst Ratings of Bronze or better. Premium members can see the full screen here. Below are three funds that made the list.

Thomas White International     
5-Year Annualized Return: -3.7% | 10-Year Annualized Return: 11.2%             
This foreign large-value fund owes some of its performance success to its outsized stake in emerging markets, which, at about 29% of the portfolio, according to the fund family's website, is 6 percentage points more than our benchmark. The fund earns praise from Morningstar fund analyst Bill Rocco for its unique process of dividing companies into valuation groups based on home country, sector, and industry. The fund's five- and 10-year returns land it in the top 11th and top 5th percentiles of its category, respectively. Fees, at 1.34%, are above-average for the foreign large-cap no-load group.

Oppenheimer International Growth (OIGAX) 
5-Year Annualized Return: -1.1% | 10-Year Annualized Return: 12.9%           
Manager George Evans looks for stocks at prices he thinks can double in three to five years and that he thinks will benefit from certain trends. For example, although only 3% of the portfolio is held in emerging-markets stocks, he's taken an indirect stake by investing in developed-markets companies benefiting from growth in emerging markets, such as European luxury goods and spirits companies. The fund holds 80% of its portfolio in Europe, well above the foreign large-growth category average of 56%, and it is underweight in financials (3.9% of holdings) but overweight in industrials (27%). The fund also has invested more than 40% of holdings in small- and mid-cap companies, more than double the category average. At 1.32%, fees are below-average for the fund's foreign large-cap front-load peer group.

Manning & Napier World Opportunities       
5-Year Annualized Return: -2.9% | 10-Year Annualized Return: 10.7%     
Despite this foreign large-blend fund's subpar trailing three-year record (80th percentile for the category), Morningstar fund analyst Katie Rushkewicz Reichart says its time-tested strategy of mixing cyclical, deep-value, and growth stocks in a benchmark-agnostic way keeps it worthy of investor consideration. The fund goes light on financials (4% of the portfolio versus 19% for the category) but is overweight in consumer defensive stocks (23% versus 13% for the category). Fees (1.09%) are average for a foreign large no-load fund.

Portfolio data for funds as of the following dates: Vanguard Total International Stock Index, Oppenheimer International Growth, and Manning & Napier World Opportunities (Aug. 31), Thomas White International (Sept. 30). All performance data as of Oct. 8