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Investing Specialists

How American's Foreign Funds Stack Up

Which of these six international funds have something to write home about?

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Capital Group, the parent company of the American Funds, has had a dedicated international research effort since the 1950s, according to Charles Ellis in his book Capital. When the firm got started, it was rare for other asset managers, save Sir John Templeton, to show much interest in or dedicate resources to international investing. In fact, the MSCI EAFE Index, the main international index, was developed at Capital Group in the late 1960s so that it could measure its performance against a benchmark.

The American Funds' experience in international investing shows through a disciplined approach and strong results: The portfolio counselors tend to build their slices of the funds they manage one stock at a time. They make investments based on the fundamental merits of businesses rather than where they're domiciled. Where a business makes its sales and where it pays its expenses can affect its profitability significantly, and profits are more important to American's counselors than where a business's headquarters are.

In this article, we'll highlight global markets performance for the year to date through August 2009, and provide the skinny on American's global and international funds, discussing how they've stacked up to peers and benchmarks during the year and over the longer haul, and how they can fit in a portfolio.

Global Markets Performance in 2009
Foreign markets have been on a tear in the second and third quarters of 2009. While the S&P 500 Index is up around 16% for the year-to-date period, the MSCI World Index, an index of developed countries, is up about 17%. The MSCI AC World Index, which includes emerging markets, leads its developed-markets sibling by 6 percentage points and is up around 23% for the year. Thus, foreign stocks have done better than domestic stocks, and exposure to emerging markets has generally boosted foreign-stock returns even more.

Indeed, emerging markets by themselves have had a torrid run: The MSCI Emerging Markets Index is up 55% for the year to date. Another popular emerging-markets index, the MSCI BRIC Index, which encompasses the markets of Brazil, Russia, India, and China, is up over 60% for the period.

Investing in emerging markets is generally considered riskier than investing in developed markets, because companies in emerging economies have shorter track records and because emerging markets are characterized by less stable governments and currencies than those in the developed world. After the first quarter of 2009, however, investors regained their appetite for risk seemingly as quickly as they lost it in late 2008.

Given this backdrop of strong foreign markets performance, how do the American Funds global and purely international funds stack up? We'll start with American's most-aggressive foreign fund and then move on to its peers, in order from the most aggressive to the least aggressive.

 American Funds New World (NEWFX)
This Analyst Pick is American's most aggressive foreign fund, though it's relatively tame by its category's standards. It's dedicated to emerging markets, but it gains exposure not only through companies domiciled abroad but also through domestic firms that derive revenues from the developing world. It also invests in bonds of emerging countries and corporations. Not surprisingly, although the fund is up 40% for the year through July, it's near the bottom of the diversified emerging-markets category. Holding developed-country stocks such as food company  Nestle (NSRGY) and pharmaceutical firm  Novo Nordisk (NVO) won't help when emerging markets are roaring. By contrast, in 2008, when emerging markets were melting down, the fund surpassed 95% of its peers.

Although its 140% cumulative return over the past decade through Aug. 31, 2009, lags the MSCI Emerging Markets Index's 155% return, we think it's worth sacrificing some return for the stability American's counselors provide and the liquidity of developed-markets stocks that do business in emerging markets. This fund is appropriate as a supporting player to one of American's large-cap funds either wholly or partly dedicated to foreign stocks, such as  American Funds New Perspective  (ANWPX),  American Funds EuroPacific Growth (AEPGX),  American Funds International Growth & Income  (IGAAX), and  American Funds Capital World Growth & Income  (CWGIX).

 American Funds SmallCap World (SMCWX)
This is the American Funds family's only small-cap fund, and it makes sense that it would be categorized in the world-stock category with other funds that can roam the entire globe--including the United States--for stocks to soak up its $15 billion asset base. It would be very difficult to limit a portfolio of that size to domestic small-cap stocks. The fund looks extremely appealing versus its world-stock peers, with a top-third performance ranking over the past decade through the end of August and a top-decile ranking for the year-to-date period. Currently, the fund has 15% of its assets in emerging markets, including a 5% stake in India alone. The emerging-markets exposure had undoubtedly contributed to the fund's 41% return for the year.

Because this fund traffics in small caps, though, comparisons with the world-stock category aren't perfect. That category contains mostly large-cap funds that serve as workhorses or core holdings in portfolios, as is the case with sibling American Funds New Perspective. A better comparison is the S&P Global Less Than $3 Billion Index, which has a cumulative return of 93% for the 10-year period through July 31, 2009. Meanwhile, this fund has produced a 45% cumulative return over the same period. For this reason, we consider this one of American's weakest offerings, though it's still a serviceable option for small-cap diversification. It can complement American's large-cap funds, including American Funds New Perspective, American Funds EuroPacific Growth, and American Funds Capital World Growth & Income.

 American Funds EuroPacific Growth (AEPGX)
This Analyst Pick is American's more aggressive large-cap international fund. It invests primarily in common stocks of firms domiciled in Europe and the Pacific Basin. Currently, it has 18% of its assets in emerging-markets stocks, which is more emerging-markets exposure than 90% of its foreign large-blend peers. Emerging-markets exposure has helped catapult the fund to a 32% return in 2009, which is good enough to place it in the top quintile of its peers. More importantly, over the longer haul, the fund has been stellar as well, producing an annualized return of 5.5% for the past decade and landing in the top decile of its category.

Investors can use this fund as their lone international holding, as it will have healthy emerging-markets exposure. The only drawback to using it exclusively is its lack of mid-cap and small-cap exposure. Only 5% of the fund is in stocks that Morningstar considers small cap or mid-cap.

 

 American Funds International Growth and Income (IGAAX)
This tamer version of EuroPacific Growth is American's newest fund. It concentrates more on dividends than EuroPacific Growth, and, accordingly, lands in Morningstar's foreign large-value category as opposed to foreign large blend. The fund maintains 9% of its assets in emerging-markets stocks, which is half of EuroPacific Growth's 18% but still more than 85% of its foreign large-value peers.

We think retirees can use this fund well as their core international holding. The fund tends to hold large- and mega-cap stalwarts such as French oil giant  Total (TOT) and the world's second-largest tobacco company  British American Tobacco (BTI). The emerging-markets exposure should provide some zip without creating too much indigestion.

The fund is up 27% for the year to date, which lands it near the top third of its peer group.

 American Funds New Perspective (ANWPX)
This Analyst Pick is American's more aggressive world-stock fund. It's similar to EuroPacific Growth and International Growth and Income in that it holds large- and mega-cap stocks, but different in that it holds domestic stocks in addition to its foreign holdings. It holds about 7% emerging-markets exposure.

In addition to its modest emerging-markets stake, the fund's technology stake has driven its 27% return for the year to date.  Microsoft (MSFT), Samsung Electronics,  Cisco (CSCO),  Oracle (ORCL), and  Google (GOOG) are among the fund's top 10 holdings. Over the past decade, the fund ranks in the top quartile of the world-stock group.

We think this fund can serve as the workhorse or core stock holding of any portfolio, though strict asset allocators may be frustrated by not knowing its exact foreign exposure at any given moment. Many investors will want to supplement it with a smaller-cap fund and something with more emerging-markets exposure. You can have a happy investment life with New Perspective as your main stock fund.

 American Funds Capital World Growth & Income (CWGIX)
This is American's tamer world-stock fund and its tamest fund altogether among the six that invest abroad. It's similar to New Perspective, concentrating on larger firms, but this fund focuses more on the most stable companies that pay dividends. It may also invest up to 10% of its assets in bonds that are rated below-investment-grade (sometimes called "junk bonds").

Although it's generally tame, it currently has around 10% of its assets in emerging-markets stocks; but that's not dangerous for investors who want to use this as their core stock holding. The dividend emphasis should damp volatility relative to its peers.

Emerging-markets exposure hasn't given the fund too much zip this year, as its 24% return lands it slightly in the bottom half of the world-stock category. Still, we'd expect this fund to lag when the markets are roaring. By contrast, its 38% loss in 2008, though very painful in absolute terms, was good enough to land the fund in the top quartile of its category. Over the 10-year period through Aug. 31, 2009, the fund's 7.6% average annual return places it in the top decile of the category. Retirees can use this fund as the workhorse core stock holding in their portfolios.

Conclusion
Although it's too early to tell with International Growth and Income, all of American's other large-cap funds that venture overseas are stellar. By contrast, New World and SmallCap World have been subpar when measured against their respective indexes. New World invests in securities that are more liquid than the average emerging-markets fund though, so it will look better when emerging markets aren't as hot as they've been in recent years. SmallCap World, though trailing its index over the longer haul, is still a serviceable diversifier.

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John Coumarianos has a position in the following securities mentioned above: MSFT, ANWPX. Find out about Morningstar’s editorial policies.