A Challenging Second Quarter for International-Stock Funds

While U.S. equity funds, particularly growth-oriented and small-cap strategies, fared well in 2018’s second quarter, conditions weren’t as favorable for international-stock funds. Concerns about a trade war with China and the impact of tariffs loomed large for global companies, with many funds building on first-quarter losses to stay in the red in 2018’s first half. A strong U.S. dollar and rising interest rates hurt many developing markets as investors shed riskier assets. Meanwhile, compared with a sanguine outlook in the United States, projections for growth slowed abroad, setting up a quarter in which the MSCI ACWI ex USA Index lost 2.6% in U.S. dollar terms even as the S&P 500 gained 3.4%.

Geopolitical concerns hit some countries particularly hard. Brazil’s projections for economic growth dipped alongside inflation concerns, high unemployment, and a plunging currency. The Latin America Morningstar Category posted the steepest loss for the quarter at 22.4%. In Turkey, questions about monetary policy, inflation, and the country’s economic position against the backdrop of a presidential election led its currency to slide. India, which imports much of its energy resources, was hit by rising oil prices.

Beyond those country-specific issues, diversified emerging-markets funds sold off broadly, losing 8.9%--the second-worst showing of any international-stock category. China-region funds, hit by concerns about the impact of tariffs and a broader economic slowdown, were down 5.5%.

There weren’t many winning categories. World large stock and world small/mid-stock, whose constituents benefited from owning some U.S. companies, posted modest gains of 0.6% and 0.5%, respectively.

As in the U.S., growth-oriented categories fared better than their value counterparts, but only modestly so. Foreign large-growth and foreign small/mid-growth funds on average were down 0.7% and 1.7%, respectively, a tad better than the 2.7% and 3.1% respective losses posted by the foreign large-value and foreign small/mid-value categories.

Outperformers
 Morgan Stanley Institutional Global Franchise (MSFAX) fared well amid turbulent international markets. It gained 4.3% in 2018’s second quarter, beating 95% of its world large-stock category peers and staying 2.6 percentage points ahead of its MSCI World Index. The compact fund, which holds around 30 names, holds mostly companies with economic moats, which provided ballast in a tough environment. It also benefited from a bidding war for  Twenty-First Century Fox’s assets, as well as its lack of emerging-markets exposure.

Currency hedging produced major tailwinds for some funds.  FMI International (FMIJX) was up 2.5%, landing near the top of the foreign large-blend category. And  Tweedy, Browne Global Value (TBGVX) was up 2.4%, the only foreign large-value Morningstar Medalist to post a gain in a choppy quarter for value-oriented funds. Relative to peers, which tend to remain unhedged, the funds benefited from the strong U.S. dollar, but they lagged the MSCI EAFE 100% Hedged Index.

 Matthews China Dividend (MCDFX), meanwhile, gained 1.1%, the only China-region medalist to land in the black. It got a boost from stock-picking within the technology sector, including Hua Hong Semiconductor (01347). Consumer defensive holding China Maple Leaf Educational Systems also helped.

Underperformers
 Invesco Developing Markets (GTDDX) was a diversified emerging-markets basement dweller. It lost 13.4% for the quarter, far worse than the MSCI EM Index’s 8% decline. Heavy exposure to Brazil hit the fund particularly hard.

 Moerus Worldwide Value (MOWIX) was similarly hurt by its Brazil stake. Meanwhile, its relative lack of exposure to U.S. stocks was a headwind, as was its value-leaning approach. Its 4.8% decline landed near the bottom of the world small/mid-stock category.

Growth exposure didn’t help all funds.  American Funds Europacific Growth (AEPGX) dropped 2.9%, worse than about 90% of its foreign large-growth peers. Keeping more than a fifth of its assets in emerging stocks held it back during the period, particularly Brazilian holdings Petrobras (PBR.A) and  Itau Unibanco (ITUB).  Nintendo (7974) also weighed on results.   

 Oakmark Global Select (OAKWX) had no emerging-markets exposure but still dropped 2.2% in the quarter, landing in the world large stock category’s bottom decile. Concentrated in 21 holdings, the fund faced weakness from top holding  Daimler (DAI), as well as others, including LafargeHolcim and  Bank of America (BAC).