The Year in International Funds

One bright spot appeared on 2014's international scene: India. That market, which suffered through an alarming decline through most of 2013, began to revive once it became clear late that year that a new prime minister with a reformist agenda would likely take office in 2014. The rally has continued, with a few bumps, throughout this year. As a result, the India equity Morningstar Category has posted by far the biggest gain--nearly 40%--of the 16 Morningstar international-stock categories for the year to date through Dec. 19. (Moreover, that's the strongest showing of any Morningstar Category in any asset class.) The next-best international-stock group, Pacific/Asia ex-Japan stock, rose just 4.7%.

Most international funds, though, sit in one of the Morningstar Style Box categories, such as foreign large-value, rather than the country- or region-specific groups. And as they did in 2013, these style box categories lagged far behind their U.S.-focused counterparts. In fact, the best performer among the international-stock style box categories (foreign large growth) declined 3.1%, landing far behind the weakest U.S. stock-fund group (small growth), which rose 1.9%.

Two culprits stand out. One was the much stronger showing of the U.S. economy compared with those in Europe and Japan, the regions that dominate the portfolios of nearly all broad international funds. Equally important has been the sharp decline of most foreign currencies versus the U.S. dollar. U.S.-based funds must translate their foreign-stock gains or losses into dollars when calculating their returns, which this year has had a substantial negative effect, save for the rare funds that hedge all or most of their currency exposure into the U.S. dollar.

How to Stay in Positive Territory
Not surprisingly, some of 2014's better-performing international-stock funds had meaningful stakes in India, hedged their currency exposure back into the U.S. dollar, or merely avoided some of the year's most notorious shoals.

 Virtus Foreign Opportunities and  Virtus Emerging Markets Opportunities (HEMZX) land near the top of their respective categories this year, helped by hefty doses of India (coming from a handful of companies that manager Rajiv Jain has liked for a long time). Not surprisingly, their generous India exposure helped put the funds well behind most peers in 2013, when that market struggled. There was more involved in these funds' performances during both years than their India holdings--for example, the emerging-markets portfolio benefited in 2014 from having almost no exposure to energy--but the India stocks had a noteworthy effect.

 Artisan International (ARTIX) also has outperformed the vast majority of its peers this year, although its shareholders might not be turning cartwheels, given that this relative success left it with a mere 0.2% gain through Dec. 19. This fund's near-avoidance of energy stocks protected it from the carnage in that sector, while it was buoyed by an allocation of roughly 4.5% of assets entering 2014 to top holding  Baidu (BIDU). That paid off when the Chinese Internet firm posted a strong gain. However,  Artisan International Small Cap (ARTJX), which has the same lead manager, did not fare as well. Its 11.5% year-to-date loss sits in the bottom quartile of the foreign small/mid-growth category. That offering has substantial allocations to individual holdings, and the poor performance of some of these stocks, rather than its country or sector biases, undermined returns.

Meanwhile, for  Tweedy, Browne Global Value (TBGVX), the woes afflicting so many currencies actually worked in its favor. As one of the very few broad international funds that hedges most of its foreign-currency exposure into the U.S. dollar, it was insulated from the deleterious translation effect. The currency hedge isn't the only reason it has the second-best return in the foreign large-value category this year, but it sure helped; a similar, unhedged version of the fund is in the 32nd percentile.

Many Unhappy Returns
What happens when a fund had relatively large weightings in both the surging India market and the plummeting energy sector? In the case of  Janus Overseas (JAOSX), the energy troubles won out. This fund's year-to-date return placed well in the top half of its category as late as the end of August. Now it's at the very bottom. An energy stake roughly 3 times the foreign large-blend average did much damage; this huge position includes many small and midsized firms whose prices fell much more heavily than those of the giants. The portfolio also included a top-five position in Petrobras (PBR), which didn't help matters.

Janus Overseas is not the only fund that found its ranking sinking in the latter part of the year. Some of these reversals have taken place in just the past few weeks. Take  Lazard Emerging Markets Equity (LZEMX). That fine fund's year-to-date return was in the 28th percentile of the diversified emerging-markets category at the end of November. Things changed quickly. Through Dec. 19, it's in the 56th percentile. An above-average weighting in Russia (and the ruble) bears most of the blame.

Interestingly, unlike some years, the performance of the diversified emerging-markets category did not differ markedly from those of the broader groups. Its average is tucked among the international style-box category averages. Within the emerging-markets category, the small subgroup of frontier-markets funds tended to land in the top half, with their lack of Russia and Brazil helping out in 2014. However, there were some attention-getting exceptions. Guggenheim Frontier Markets ETF fell roughly 16%, and Templeton Frontier Markets not only lagged other frontier-markets funds, it landed dead last in the diversified emerging-markets category. A huge overweighting in energy stocks helps explain that fund's painful 19.3% decline.