4 Foreign-Stock Funds That Aren’t Scared of Emerging Markets

Emerging markets have seen more downs than ups lately. In 2011, as investors fled to safety amid macroeconomic concerns, the MSCI Emerging Markets Index, or EM Index, lost 18%--somewhat worse than the 12% loss of the MSCI EAFE (composed of developed-markets stocks) and far behind the S&P 500's 2% gain. And in 2013, while the two developed-markets benchmarks roared to new highs, the EM Index lost 3%. True, performance has improved in 2014: The EM Index has beaten the EAFE through July 23 (though it lags the S&P 500), and, outside of China and Korea, emerging markets have largely surpassed developed ones.

Nevertheless, emerging markets' bout of underperformance since the start of 2011 has left them trading at a larger discount to developed markets than in the recent past. At the end of June 2014 on a price/earnings basis, the EM Index traded at a 33% discount to the S&P and a 23% discount to the EAFE. That nearly matches its peak discount to the S&P over the past five years and substantially exceeds EM Index's discount over much of that span. Meanwhile, EM Index’s discount to the MSCI EAFE Index is wider than it was at the end of each of the past five calendar years.

To be sure, there are fundamental reasons why emerging markets have become relatively cheaper: China’s growth has slowed, Brazil's and India’s governments have had rocky relationships with key companies in their countries, and inflation has risen in some spots. But emerging markets offer a potentially appealing contrarian opportunity, even though it’s not as much of an against-the-grain play as it was at the start of 2014. For investors wary of buying pure plays, here are several diversified foreign funds that are open to new investors, earn Morningstar Medals, and offer significant exposure to emerging markets. We’ll start with some relatively stable options, then highlight a couple of higher-risk choices.

 AllianzGI NFJ International Value (ANJIX)
Morningstar Analyst Rating: Silver
This fund seeks cheap dividend-paying stocks and regularly finds a big slug of them domiciled in developing markets. Its emerging-markets stake has reached one third of assets at times, and it exceeded 30% at the end of June 2014. While this trait has caused the fund to lag its typical foreign large-value peer at times (such as 2013), it hasn’t resulted in excessive volatility. The managers will trim their emerging-markets stake when valuations aren’t compelling, and sticking strictly to dividend-payers means the fund typically owns financially sturdy fare. This sensible approach has resulted in a superb record; the fund has beaten more than 95% of its category peers on both a total-return and risk-adjusted basis from its 2003 inception through July 23, 2014. Lead manager Benno Fischer has been on board for that entire span, while three of his five comanagers have served on the fund for at least six years.

 Columbia Acorn International (ACINX)
Morningstar Analyst Rating: Silver
A focus on small- and mid-cap growth stocks combined with a willingness to invest heavily in emerging markets at times can make for turbulent returns. This fund sported an average market cap of $3.2 billion at the end of June and stashed close to 30% of its assets in developing markets. But the strategy of managers Zach Evan and Louis Mendes--avoid paying too much for growth and favor higher-quality firms within their universe--has kept somewhat of a lid on volatility. Indeed, the fund held up better than roughly two thirds of its foreign small/mid-growth peers when emerging-markets stocks lost more than developed-markets ones in both 2008 and 2011. True, the cautious elements of the duo’s approach have caused it to lag two thirds of its peers during the rally that has marked much of the past five years through June 23. But it’s surpassed all but one of its category rivals on a risk-adjusted basis since Egan and Mendes took the helm in May 2003.

 Janus Overseas (JAOSX)
Morningstar Analyst Rating: Bronze
This fund is far more aggressive than the two above. Manager Brent Lynn will go wherever he finds value, and that often has meant a volatile mix of aggressive-growth stocks and value plays, as well as an emerging-markets stake that comprised nearly half of the fund’s assets at the end of March 2014 (the foreign large-growth norm was in the single digits), including a 23% stake in India. Lynn will also stuff more than half of the assets into the fund’s top 10 holdings at times, though that stake was recently trimmed to a still-large 45%. His appetite for developing markets, coupled with overly optimistic assessments of firms such as  Petrobras (PBR) and Li & Fung, led to awful absolute and relative results from 2011-13. But Lynn’s previous record since taking sole control of the fund in mid-2003 was superb. Over his full tenure, the fund has beaten more than 90% of its foreign large-growth peers, but thanks to its poor performance in downturns, it’s only modestly ahead of the category norm on a risk-adjusted basis and has trailed its MSCI ACWI ex USA benchmark. This fund is best used in small doses and is only for the patient.

 TCW International Small Cap 
Morningstar Analyst Rating: Bronze
This bold fund has gotten off to a rough start. From its early 2011 inception through July 23, 2014--a period that coincides with emerging markets’ slump--it has trailed all of its foreign small/mid-growth peers. But although risk-taking and stock-picking errors have hurt, the fund is worth watching. Manager Rohit Sah amassed a strong record in a seven-year tenure at Oppenheimer International Small Cap (OSMAX) plying a similar strategy: He uses macroeconomic analysis to help determine the most promising sectors and at a bottom-up level seeks companies with modest debt and strong cash flow prospects. Some of his favorites are too small to cross the radar screens of his competitors; the fund’s average market cap is just one fourth of the category norm. A taste for commodities and natural-resources firms has also typically led to a huge emerging-markets stake (more than 40% at the end of June). Thus, although the fund holds promise, it’s best limited to a small role in a diversified portfolio by investors with long time horizons.

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