International Equity Funds Bounced in Second Quarter

Following a catastrophic start to the year, international equities rebounded sharply in the second quarter. The bellwether MSCI ACWI ex USA benchmark rose 16.1%, bringing its year-to-date return to a slightly more palatable negative 11.0%. Emerging markets, which suffered a greater decline during the first quarter, regained 18.1% versus a 15.3% increase for international developed markets. Regional performance followed a similar pattern as Latin American, Australian, and European markets rebounded more strongly following larger losses than Asian equities in March.

Value stocks didn’t see the same rebound, though. After falling 28.6% in the first quarter, the MSCI ACWI ex USA Value Index clawed back 12.8% in the second quarter, but its growth counterpart gained 19.1% after a loss of just 18.3%. Typically, one would expect the weaker-performing segment to make up more lost ground after a change in sentiment, but the coronavirus pandemic’s market impact had the opposite effect. Demand for growth-oriented technology, e-commerce, and healthcare stocks increased as investors piled into companies largely insulated from the effects of mandatory lockdowns. Winners included the likes of Canadian e-commerce platform company Shopify SHOP, which more than doubled during the quarter.

The extreme disparities in performance are reflected in current valuations. Using Morningstar's equity data, international growth stocks are twice as expensive as value stocks on a price/earnings basis, the widest spread since comparable data is available beginning in 2007. The discounts in value equities are apparent in the yields they offer, too. Value stocks carry a whopping 4.7% weighted-average dividend yield, with more than a few offering double-digit yields. While eye-popping, these metrics aren't so surprising considering value equity's struggles on an absolute and relative basis. Over the past five years, the MSCI ACWI ex USA Value Index has fallen 1.2% on a total return basis, while growth has gained 5.6%. Similar to the story in U.S. equities, investors hoping for a reversion to value are still searching for signs.

Funds Posting Big Gains Growth-oriented funds continued to shine. Among the best performers was Vanguard International Growth VWIGX, whose 33.0% second-quarter return ranked in its foreign large-growth Morningstar Category's top decile. The strategy's bent toward e-commerce companies such as Argentina's online marketplace MercadoLibre MELI and U.K. online grocer Ocado Group PLC OCDGF was a key contributor. The two stocks' stellar 2019 performances continued into 2020, gaining 72.4% and 58.6% on the year, respectively, despite the broader market turmoil.

Following a tumultuous March, Oakmark International OAKIX rebounded in a big way, gaining 24.4% in the second quarter, good for a place within the top 5% of foreign large-blend peers. The fund’s more cyclical holdings in banks and industrials led the charge. Stocks like BNP Paribas BNPQF and British industrial firm Ashtead Group ASHTF saw meaningful recoveries in their prices following precipitous declines in March. Another key contributor was South Korean technology company NAVER NHNCF, which gained over 50% during the quarter. Despite the bounceback, the fund’s negative 23.0% year-to-date return still ranks among its category’s worst.

Funds That Underwhelmed During the Rally Like many of its peers, Lazard Emerging Markets Equity LZOEX struggled during the drawdown, but it didn't keep up during the recovery. Its 12.4% second-quarter return ranked in the diversified emerging-markets category's bottom decile. Stock picks within energy, technology, and communication services were the key culprits. For example, Chinese telecom provider China Mobile CHL declined 7.9%, versus a 23.5% increase among communication services stocks within the MSCI Emerging Markets benchmark.

IVA International IVIOX posted a weak performance in the second quarter, rising just 9.9% relative to a 15.5% gain for its average foreign large-blend peer. The fund’s variable cash stake often serves as a buffer in down markets, while acting as a drag in up markets. This year was a bit of an oddity, though. The fund’s cash stake didn’t prevent it from falling in line with its benchmark during the calamitous first quarter as its consumer and financials holdings lagged. The fund’s picks fared better in the second quarter, but the cash allocation then had its usual effect of damping returns.