A Downgrade for This Foreign-Stock Fund

The following is our latest Fund Analyst Report for Tweedy, Browne Global Value Fund TBGVX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Tweedy, Browne Global Value's 2017 struggles are largely cyclical, but concerns about the fund's growing expense gap and the team's future composition are long-term issues. Those issues lead to a downgrade of its Morningstar Analyst Rating to Bronze from Silver.

This fund has been on the wrong end of the currency market in 2017. Hedging most of its foreign-currency exposure has helped the fund versus most of its foreign large-value Morningstar Category rivals over the past 10 years, as the dollar has generally appreciated versus most developed currencies during that time. But the dynamic has reversed so far in 2017, with the unhedged MSCI EAFE Index up 17.1% through July versus 9.1% for this fund's benchmark, the MSCI 100% Hedged Index. In that light, the fund's 11.9% year-to-date gain looks quite good. That said, the fund still trails its benchmark by a wide margin over the past five years mainly because of its value orientation, although it beats its typical peer.

More troubling is the growing gap between the fund's expense ratio and what its median peer charges. In 2013, the median no-load foreign large-cap fund charged 1.11%, but that figure has dropped 9 basis points to 1.02%. Meanwhile, this fund's expense ratio has returned to 1.38% per its 2017 prospectus, leaving it 36 basis points more expensive than the median. This is a big hurdle for the fund to overcome year in and year out versus its cheaper peers, especially if the median fee keeps falling.

The four lead managers have shown that they're up to the task over the long run, but it's fair to ask how the team's composition might change in the future. While the managers say they have no plans to step aside, it's tougher to be confident that the lineup won't change at some point in the next five years or so given that Will Browne is 72 years old and John Spears is 68. Three senior analysts are on the investment committee, and they would likely fill any vacancies, but they do not have public records of their own. So, while this remains a very experienced and well-resourced team, there is some uncertainty on the horizon.

Process Pillar: Positive | Kevin McDevitt, CFA 08/23/2017 It will buy deep-value names, but this fund's team prefers to own quality stocks with strong franchises over the long term. The managers often invoke Ben Graham, but their style also incorporates Warren Buffett. They will happily pay a fair price for a good firm such as Nestle NESN. They hold such positions for years, using a long time horizon to their advantage and earning the fund a Positive for Process. Turnover is typically below 15%, partly in an effort to minimize capital gains. The team opportunistically buys lower-quality stocks selling at depressed multiples, too, but these are quickly unloaded once they recover.

The fund's all-cap approach gives another edge. Rather than sticking to the large-cap universe, the team will go up or down the market-cap ladder depending on where it finds the best values. In the late 1990s, more than half the portfolio was in mid- and small-cap stocks. As small- and mid-cap valuations rose over over time, the combined weighting has fallen to 16% of assets.

The team's valuation consciousness and willingness to hold cash have helped make this one of the foreign large-value category's least-volatile funds. The team builds sizable cash stakes when it can't find attractively priced stocks. Hedging the portfolio's perceived economic foreign-currency exposure (sibling Tweedy, Browne Global Value II TBCUX is unhedged) and largely avoiding emerging markets further limits volatility.

Although it lets its winners run more than some value managers do, this fund's team has been showing its value leanings. The team has trimmed the huge consumer staples position, which had served shareholders so well, from 32.0% of assets in December 2011 to 15.8% in June 2017. Some of the proceeds have been reinvested in banks and insurance companies, giving the fund a 20.4% financials weighting, just below the MSCI EAFE Index. Despite the persistent equity rally, the team let cash fall to 5.7% of assets as of June 2017. This is the fund's smallest cash stake in six years.

With less invested in high-quality consumer staples stocks, purchases the past three years have been more value-leaning. The fund began building its energy stake in mid-2011, including integrated majors Total TTA and Royal Dutch Shell RDSA, which now stands at 6.1% of the portfolio. Although the team likes companies with strong brands and pricing power over more-commodity-oriented businesses (the portfolio has hardly any telecom or utilities exposure, for instance), it will buy the latter when valuations become compelling. The team believes there's a sufficient margin of safety even as oil and gas prices have fallen sharply since June 2014, as many such stocks trade below 1 times sales. Partially offsetting this foray into energy, the team has reduced the fund's positions in cyclical sectors such as industrials and consumer discretionary firms.

Performance Pillar: Positive | Kevin McDevitt, CFA 08/23/2017 This fund's results must be framed by its hedging policy. Management hedges the portfolio's perceived economic foreign-currency exposure. This means the fund hedges about 75% of its nominal foreign-currency exposure. Few peers do the same, and it leads to huge differences in relative returns. (It has also given the fund a strong tailwind over the past five years.)

But the fund's hedging policy hardly explains its long-term success, which earns it a Positive Performance rating. During the trailing 15 years, the fund's 8.3% annualized gain beats its MSCI EAFE 100% Hedged benchmark by 1.6 percentage points as well as the unhedged MSCI EAFE Index by 1 percentage point through July 2017. It has also beaten the foreign large-value category average by 1.3 percentage points.

Its record looks even better on a risk-adjusted basis. The fund owns the category's lowest Morningstar Risk scores for the trailing three-, five-, and 10-year periods. The fund had one of the category's best showings during the 2008 financial crisis, and it outperformed again during 2011's choppy market and the 2015-16 bear market.

But dry spells come with the territory, and the fund tends to lag during robust bull markets, as it has during the past five years. Results have been hurt by bets on energy stocks and banks, although top-20 positions HSBC Holdings HSBA and DBS Group have bounced back in 2017.

People Pillar: Positive | Kevin McDevitt, CFA 08/22/2017 This fund has one of the more experienced management teams in the world large-stock category and earns a Positive People rating. While comanager Chris Browne's retirement in mid-2009 was certainly a loss, the four managing directors and lead managers (Will Browne, John Spears, Thomas Shrager, and Bob Wyckoff) have all been on the fund since its 2007 inception. The team members take a collaborative approach to investing, as they tend to see the world in a similar way. In conversation, the managers often finish each other's sentences.

The management team is supported by a deep bench of nine analysts, including several career analysts. That depth may be called on in the years to come as some of the principals finish out their careers. Browne is 72, Spears is 68, and Wyckoff and Shrager are in their 60s as well. The firm laid the groundwork for future succession when it promoted analysts David Browne, Roger de Bree, and Jay Hill in July 2013 to the investment committee. Those three were also added as comanagers, although the four managing directors retain final authority.

However, David Browne left the firm in May 2015 to start a hedge fund. (Junior analyst Will Browne left the firm in May 2016 to join him.) Longtime analyst Frank Hawrylak took his place on the investment committee. The firm hired two new analysts in May 2016: Amelia Koh and Andrew Ewert.

Parent Pillar: Positive | Kevin McDevitt, CFA 09/16/2016 Tweedy, Browne has done much to align its management team's financial interests with those of fundholders. Manager ownership of fund shares is very strong. Each of the firm's funds has at least one manager with more than $1 million invested. Current and retired principals, directors, and employees have more than $1 billion invested across the firm's portfolios as of June 30, 2016.

Transparency and shareholder communications are also excellent. The team writes thorough annual and quarterly letters, addressing shareholders as partners. The managers also tend to be candid about their mistakes. As these attributes suggest, Tweedy is not a marketing-directed firm. It has been around since 1920 but offers only four funds (and only three distinct strategies). The firm further demonstrated its fiduciary commitment by closing Tweedy, Browne Global Value TBGVX and Tweedy, Browne Value TWEBX to new investors in May 2005. Tweedy, Browne Global Value II TBCUX closed in August 2014. All three funds subsequently reopened. The firm also limits large one-time purchases.

Such excellent stewardship makes the above-average costs on the firm's four funds--as determined by Morningstar's Fee Level measure--that much more disappointing. With $10.2 billion in assets (as of September 2016) across these U.S.-based funds alone, the firm should do more to share economies of scale with shareholders.

Price Pillar: Negative | Kevin McDevitt, CFA 08/22/2017 This fund's expense ratio is a disappointment for an otherwise fundholder-friendly firm. Its 1.38% expense ratio is well above the 1.13% median for no-load, world large-stock funds. Morningstar rates its overall fees as Above Average. Such a high expense ratio means that it will be difficult for the fund to consistently deliver a net payout greater than the MSCI World High Dividend Yield Index. The firm does not have a good record of passing savings along to shareholders. For this reason, the fund has a Negative Price rating. The fund's low trading costs are a modest saving grace. Its 2017 brokerage commissions were just 0.03% of average net assets.