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Commentary

Juicing Up With Japan

Over the past few years, many shareholders of domestic-stock funds have become painfully familiar with the vague but ominous phrase "out of favor." Portfolio managers complain that they can't be expected to perform well when cyclicals, or small stocks, or banks, or whatever else they happen to own, are out of favor in the market.

Sometimes these complaints are merely attempts to distract you from poor judgment or flawed strategies. But they can also serve as legitimate explanations for a fund's troubles. Now, similar market trends have affected international funds--and the phenomenon is tossing the category around in surprising ways.

Until fairly recently, the choices available in most foreign stock markets were quite limited, so international-fund performance couldn't be explained in terms of the strength of cyclicals or similar broad generalizations. Even looking at country allocations only told you so much, because the main story line there was simple: Everyone underweighted Japan. (With the huge Japanese economy in a decade-long tailspin, that move alone enabled most funds to consistently beat MSCI's EAFE index, the most common foreign benchmark.) Nearly all funds focused on big stocks. Emerging markets added some spice to this bland menu, but for long stretches, their impact was almost uniformly negative.

All that has changed. First, 1998 saw a decided tilt away from value stocks in foreign markets, and the twists have continued in 1999. Japan's stock market has come roaring back. Asian emerging markets skyrocketed before cooling in recent months--and they're no longer acting in sync with other emerging markets. Small-cap stocks, which struggled for years, have vastly outperformed their larger brethren in some markets. These changes mean that evaluating your foreign fund's performance is no longer as simple as it once might have been.

Juicing Up With Japan
It's worth keeping these changes in mind when looking at the foreign-stock category's surprising year-to-date rankings. Some of the funds sitting in the cellar (as of October 18) were the same ones that had been highly regarded when 1999 began: namely, BT Investment International BTEQX, Harbor International Growth HAIGX, United International Growth UNCGX, and Vanguard International Growth VWIGX. When you look at their portfolios now, one thing stands out: They don't think much of Japanese stocks. In their most recently available portfolios, none of these funds came close to the category's average Japan stake of 17%, much less EAFE's weighting of roughly 23%. Of these four funds, Vanguard International Growth, with a 13.7% stake, has the highest Japan weighting. Harbor International Growth has no stake in Japan whatsoever. With Japan's market outdistancing all other developed markets this year, it's little surprise that these funds rest near the category's bottom.

 Suffering from a Lack of Japan
% of Assets
in Japan
YTD Rank in
Category (%)
5-Yr Rank at
end of 1998
United International Growth UNCGX 9.8 69 6
Vanguard International Growth VWIGX 13.7 94 20
BT Investment International BTEQX 8.9 97 1
Harbor International Growth HAIGX 0.0 99 4
Category Average 17.0 -- --
Although a small Japan stake hasn't guaranteed weak performance in 1999, it has helped send these fine funds to the bottom. Note: Japan % as of latest portfolio. YTD rank as of 10-18-99.