The Year in International-Stock Funds

Investors in international-stock funds aren’t likely to recall 2015 fondly. A variety of factors conspired to make it tough to post any gains at all. That said, given the headwinds, for most funds the results could have been worse.

Through Dec. 18, the large-cap categories have been the most challenged among the "style-box" international-stock groups. None are in positive territory. The best performer, the foreign large-growth Morningstar Category, has a 0.4% loss, while foreign large-blend and foreign large-value are deeper in the red, at negative 3.1% and negative 4.6%, respectively. The world-stock category, whose funds typically have about half of their assets in the United States, lands in between the latter two categories.

Funds that focus on smaller stocks fared better--a contrast with the U.S. fund categories this year. The foreign small/mid-growth category gained 4.9%, while the other two small/mid-groups posted lesser gains.

Looking to more-specialized categories, it is not hard to see where the most serious difficulties arose this year. The five lowest returns for the 15 international-stock groups all came from categories that focus on emerging markets. The funds that invest most broadly, which are placed in the diversified emerging-markets category, are down an average of 14.5%. Even worse is the Latin America stock category, which has plunged nearly 30%, with the woes afflicting Brazil accounting for most of the trouble. Overall, only the Japan-stock category really shone; its average rose a healthy 10.6%, the best performance of any international-stock category.

Beneath the Surface Within the categories there were pockets of sunlight. As in the U.S. market, growth stocks outperformed. Therefore, in the world-stock category, which includes funds that adopt many different security-selection strategies, those funds with growth-oriented approaches posted the highest rankings--and the stronger the growth emphasis, the better. At the bottom of that category lie infrastructure funds, which were sunk by high stakes in the energy sector or concentrations in other economically cyclical sectors such as industrials.

Even in the more narrowly focused style-box categories, the funds that lean toward growth compared with their category peers came out ahead. For example, in the foreign large-value group, funds whose portfolios edge closer to the blend border (or even sit in the blend space currently) outperformed, while more value-leaning funds--often those with a dividend mandate--clustered toward the bottom of the category.

Another factor affecting performance was the degree to which funds were exposed to emerging markets. Because of China’s economic slowdown and the related decline in commodities prices, many stocks in countries that supply those commodities (which describes many emerging markets along with others such as Canada and Norway) took quite a hit. Other headwinds included a rising U.S. dollar, which made investors wary of emerging markets, and economic sanctions on Russia (which also suffered from the decline in oil prices). Meanwhile, Brazil not only faced these broader concerns but a long-lasting, messy scandal at Petrobras and political turmoil that has ensnared many of the country’s most prominent leaders.

On the other end of the spectrum, Japan provided solid returns in 2015 that were even more notable when judged in U.S. dollar terms, because the yen held up better than the euro and many other currencies. Therefore, funds with low stakes in Japan relative to their benchmark and peers tended to suffer in comparison to rivals, though the extent of the impact depended on which Japanese stocks they owned (or didn’t own).

As noted, currency effects--as always--played a role in international-fund returns. Most U.S.-based funds are fully or almost fully unhedged, which means that declines in foreign currencies versus the U.S. dollar damp their returns because those returns must be translated into dollars. In fact, most European markets were in positive territory in local-currency terms but not after the currency translation. The plunge in Brazil’s currency made unpleasant stock market returns much worse in U.S.-dollar terms. Funds with investments in South Africa suffered a similar fate.

A Look at Selected Funds

That currency impact was visible at Tweedy, Browne. One of the few funds that does hedge most of its foreign-currency exposure into the U.S. dollar,

Meanwhile, a very good fund that suffered this year from its emerging-markets exposure is

Conversely, the strongest performer in the foreign large-blend category,

However, a deeper look into the portfolios shows why sector and regional weightings sometimes don’t fully explain a fund’s performance. Dodge & Cox Global Stock’s second-biggest emerging-markets holding, South Africa-based Internet company Naspers, is actually up more than 35% for the year to date. And the fund’s top emerging-markets holding, Samsung Electronics, is only down 4%. But a stock not included in the emerging-markets weighting, U.K.-based bank Standard Chartered, has tumbled 35% so far this year--mainly because of its extensive business in emerging markets. And U.S.-based stocks Hewlett-Packard, Time Warner, and Schlumberger also caused the fund more pain than some of its emerging-markets holdings.

Finally, investors who owned dedicated emerging-markets funds had a rough go of it. Only a handful of funds in the diversified-emerging-markets category--for the most part, those focused on small caps--managed tiny gains or held their losses to a minimum. Much more common were double-digit losses, with a number of diversified-emerging-markets funds enduring losses of 20% or more.