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4 High-Conviction Foreign-Stock Funds

Russel Kinnel

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. With some prominent foreign-stock funds shutting their doors, some investors interested in globalizing their portfolios may be on the hunt for new ideas. Joining me to share some foreign-stock fund favorites is Russ Kinnel. He is director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: One thing I have been thinking about is whether, in light of the fact that foreign stocks have underperformed U.S. for a few years here, investors are perhaps losing faith in foreign-stock investing. And what are some reasons to think about making sure that you have a global portfolio?

Kinnel: I think some [investors] are. They look at their returns in emerging markets or foreign developed markets and see these meager returns compared with U.S. funds. So, I think it always tries people's patience when that happens. And of course when that happens, sometimes we will start to come up with stories about how U.S. companies are great. I remember in the late '90s we started to hear lots of stories saying, "Why invest overseas? The U.S. is so superior." And of course, usually when you hear that, it means we are setting ourselves up for a fall because the U.S. is going to lag the next few years. It's not guaranteed, but that tends to happen.

Benz: And there is some indication, perhaps, that foreign-stock valuations are maybe not a screaming buy right now but perhaps lower than U.S. valuations currently.

Kinnel: That's right. Emerging markets, even though they have still remained somewhat popular with U.S. investors, have more or less done nothing the last five years. Developed markets, elsewhere, have done a little better than that; but again, the strong dollar has weakened that so that a U.S. investor saw even worse returns the last couple of years. But obviously, Europe's been stagnant, so valuations do look pretty cheap. If you look at some of the asset allocators like GMO or Rob Arnott's group, they tend to have projections for better returns overseas than in the U.S.

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Benz: And not just in emerging markets, but in developed foreign markets as well.

Kinnel: That's right.

Benz: Another confounding factor here is that we've recently seen some prominent foreign-stock funds if not close altogether, at least take steps to limit purchases by new investors. Dodge & Cox International (DODFX) is the most recent. Oakmark International (OAKIX) has had limited purchases for a while; the same goes for Artisan International Value (ARTKX). So, if these managers are on the hunt for cheap stocks and you think that perhaps there are some opportunities, why are they, in fact, limiting purchases?

Kinnel: I think, even though foreign returns have been somewhat disappointing, people have still found the really strong performers. So, Dodge and Artisan and Oakmark have had pretty solid inflows for a number of years. So, from their universe, they are just [asking themselves] how much they can run. It's not so much a factor of whether there are opportunities out there. It's just that they don't want to have money exceed their ability to research good ideas. It's not so much a market call. On the other hand, there are still many other funds that do have more capacity and, therefore, look like good opportunities for U.S. investors.

Benz: I want to talk about some of those. But before we leave the fund-closing idea, you generally think that that's a good idea from a stewardship standpoint for managers to know their own limits in terms of how much they can run successfully.

Kinnel: I absolutely do. I love it when funds close to new investors. It means they are putting shareholders first. Sometimes funds play a little fast and loose, and they will try and wait until a problem erupts before they close the doors. And the problem is that often it's too late. They have to adapt their style. Maybe some of the things that were contributing their past success, say small caps or other kinds of strategies, can no longer contribute because the fund has gotten too big. So, I really think it's a good way to take care of shareholders. I think it's a great sign when that happens.

Benz: So, you brought a short list of high-quality foreign-stock funds that investors might consider, might put on a list of funds to research further. American Funds International Growth and Income (IGAAX) is here. This is one that, if people are working through an advisor, they may need to pay a sales charge to own it.

Kinnel: That's right.

Benz: Let's talk about what makes it a good pick from a bottom-up basis.

Kinnel: Well, American is a firm that's typically done a really good job with a low-turnover, dividend-focused strategy. This is really their only foreign fund that does that. They've got world-allocation funds. They've got world-stock funds. But this is really the only foreign fund that does that. It's got a decent yield, and it's relatively and new relatively small. By that, I mean it was launched in '08; it's got about $10 billion AUM--which, by American Funds standards, is small. But I think they do a very good job with that dividend strategy. As with all other American Funds, it has pretty low costs outside of the load. So, it's a really good long-term investment.

Benz: Another fund on your list--kind of a tried-and-true name--is Vanguard International Growth (VWIGX). It's recently had a little bit of tweaking going on with the manager teams. It's also getting to be a large fund. I just looked--it's $21 billion currently. What's the case for owning this fund, especially perhaps relative to maybe a foreign-stock index fund?

Kinnel: Well, an actively managed fund with three subadvisors, lots of stocks, and lots of assets [can make you] think, "This is boring, this is a closet index fund--why should I bother?" To me, the answer is, for one, the costs are almost as low as an index fund. So, with closet indexing, I hate that if it's charging 150 basis points; but if it's almost as cheap as an index fund, then what's the problem? But this fund has actually beaten Vanguard Total International Stock (VGTSX) over the last 15 years--and more recently as well. So, clearly, they are able to add value. When you have low costs, the hurdle is not that great.

You mentioned manager change, and there has been a change recently at M&G Investment, but they only run about 13% of the fund. Baillie Gifford runs 50% and Schroder runs about a third. So, yes, it's an issue to have a new manager from the M&G side; but again, it's kind of like if a company changed the division head who is responsible for 13% of the revenues--it's probably not going to change your overall thesis of a company. It's the same with a fund; that's not the main driver of success here. But again, when you have a low expense ratio, that makes a low hurdle for the managers. They don't have to have a lot of value for investors to come out ahead.

Benz: A good point. Another fund on the list, maybe a little less well known to our viewers, is Virtus Foreign Opportunities (JVIAX). Let's talk about the case for that particular fund.

Kinnel: It's a really interesting fund to me because it's kind of a mix of conservative and aggressive. Rajiv Jain looks for steady growers at reasonable prices. So, you have a lot of standard foreign-equity names like Unilever (UL) and Nestlé (NSRGY); but on the other hand, if you look at the way he plays Asia, he doesn't have much in Japan or China--which, of course, are the two dominant players. He's got a lot in India. So, that makes the fund perform a little differently. It makes it a little more volatile than it otherwise would be because India is much more volatile than Japan and even more than China, which is volatile on its own. So, it's kind of an interesting mix of caution and aggression. It's still a relatively small fund--about $2 billion AUM--but he has obviously made it work. You look at the track record and you say, "Here is a manager with a small asset base who really has picked stocks well over time."

Benz: India was a rare bright spot among foreign markets last year. Should that be cause for concern? Should investors buying it now maybe temper their expectations for really great near-term returns?

Kinnel: That's right. That Asia bias really means that in year-to-year performance, how India did relative to China and Japan is going to be a big part of the story. So, yes, after India has had a good runup, that might mean maybe the fund will cool down a little. But that's not the only thing going on at the fund. I think, long term, it shouldn't matter that much. But yeah, don't expect it to do as well as it did last year, at least on a relative basis.

Benz: Last question for you, Russ. These are three active funds that you've highlighted. What do you think about indexing overseas? Is that a viable alternative as well?

Kinnel: Most definitely. I think indexing is another great way to go. Vanguard Total International Stock is probably my favorite because it's got a little more emerging markets. Some foreign-equity indexes are purely devoted to developed markets. But this one has got about 15% of assets in emerging. So, I think it's more of a complete coverage with emerging thrown in there--and of course, it's very cheap and well run.

Benz: Russ, thank you so much for being here to share these picks.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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