Foreign-Fund Ideas for Contrarians
Their near-term results look terrible, but their unloved holdings could be due for a comeback.
Stocks are expensive by many measures. Though the average price/fair value for stocks in Morningstar's global coverage universe doesn't point to egregiously high equity prices--it's been bouncing around at slightly over 1.0 since early 2013--other measures send a more pessimistic message.
The Shiller P/E for the S&P 500--a cyclically adjusted measure--is currently 27, versus a long-term median of about 16. Ominously, that's right about where it was before the financial crisis in 2008.
The firm Grantham, Mayo, Van Otterloo & Co.'s latest seven-year asset-class return forecast is similarly gloomy about stocks' prospects. Ben Inker, co-head of the firm's asset-allocation team, said in a recent interview that "U.S. stocks look expensive to us, more or less across the board." He singled out U.S. small-cap stocks as being particularly unattractive at the moment, saying that their valuations are at the highest level GMO has ever seen.
Of course, asset-class-return forecasts don't always pan out. And even though GMO's asset-class-return forecasts have been quite prescient over longer time frames, the firm has frequently been early in its predictions of stocks' demise. (Its forecasts are for the next seven years, after all--not for the next two months or two years.)
That said, valuation has historically been the best predictor of market performance, so savvy investors would do well to incorporate a measure of valuation sensitivity into their portfolio-management process. For individual investors not comfortable trying to figure out whether stocks and bonds are cheap or expensive, the best way to keep a portfolio attuned to valuations is to adhere to a regular rebalancing strategy. After all, it's a good bet that an investor's most highly appreciated holdings are also on the expensive side, while those that have slumped are cheaper.
For investors who haven't rebalanced their portfolios in recent years, it's likely that a) their portfolios are heavier on stocks than they should be, and b) the stock portions of their portfolios skew heavily toward U.S. stocks. After all, the MSCI EAFE Index has gained just 6% on an annualized basis during the past five years, whereas the S&P 500 has returned 15%.
A big part of that performance differential, as senior analyst Kevin McDevitt discussed here, owes to the fact that the dollar has ascended relative to the euro and yen. That means that foreign stocks aren't universally cheap, so investors in search of bargains overseas will need to pick their spots. As Inker notes in this video, both value and emerging-markets stocks (and better still, value stocks in emerging markets) appear to have more potential than growth-oriented names in developed markets.
Trouble is, several good-quality, value-leaning foreign-stock funds with the latitude to invest in emerging markets are unavailable to new buyers. Artisan International Value (ARTKX) has long been closed, Oakmark International (OAKIX) has limited new investors for the past several years, and Dodge & Cox International Stock (DODFX) recently shut its doors. (Interestingly, only Dodge has a sizable stake in emerging-markets names currently.)
To help shine a light on worthy value to blend foreign-stock funds with sizable emerging-markets weightings, we turned to Morningstar's Premium Fund Screener. We screened for foreign large-blend and foreign large-value funds that earn Morningstar Analyst Ratings of Bronze or higher and feature emerging-markets stakes of at least 10%. We also screened out funds that are closed or otherwise limiting new investor purchases. Premium Members can click here to see the complete list of funds that cleared our hurdles.
A key caveat: Several of the funds that made the cut employ strategies that can go deeply out of favor from time to time. Their performances have struggled over the past several years, in part, because of their hefty allocations to emerging markets.
Here's a closer look at some of the funds that made the cut.
Allianz NFJ International Value (ANJIX)
Category: Foreign Large Value | Analyst Rating: Silver | Emerging Markets: 24%
For investors who believe in reversion to the mean, this fund looks like just the ticket. Not only has performance struggled, but its portfolio features heavy weightings in some unloved areas. Its emerging-markets stake has historically been on the high side relative to other diversified foreign-stock funds, and that has crimped returns as emerging-markets names have lagged developed. In addition, management's dividend focus has held back returns as investors have generally favored more growth-leaning names; the fund's most recent portfolio featured a sizable position in flagging energy names. That said, the consistency with which management applies its dividend and valuation focus across all of its funds is appealing. The fund also currently sports a yield that's attractive in absolute terms. It may carry a sales charge for investors who purchase it through a financial advisor.
Longleaf Partners International (LLINX)
Category: Foreign Large Blend | Analyst Rating: Bronze | Emerging Markets: 20%
This fund's managers invest with conviction and without regard for market benchmarks, employing an approach that is concentrated, deep value, and low turnover. As a result, the portfolio is filled with unloved--and often obscure--names. That has contributed to strong returns over very long time frames, but performance has been incredibly erratic. The fund is in the midst of one of its weak patches right now: As casino- and mining-related holdings have struggled, its returns land in or near its category's bottom decile in every trailing period from one month to 10 years. (Its 15-year numbers remain topnotch.) Senior analyst Gregg Wolper lauds the fund for its seasoned management team and potential for long-term outperformance, but he notes that it's only appropriate for investors who understand and support its approach. Alas, even many of its shareholders have not stuck with it through its rough patches: During the past 10- and 15-year periods, investor returns have lagged the fund's total returns.
Vanguard International Value (VTRIX)
Category: Large Blend | Analyst Rating: Bronze | Emerging Markets: 12%
With three distinct management teams running this fund for Vanguard, it's probably not surprising that its performance has generally been more even-keeled than the two aforementioned funds. But analyst Alec Lucas notes that the fund isn't without an edge, thanks in part to the influence of deep-value shop ARGA Investment Management, which runs about 25% of the fund. (Lazard Asset Management and Edinburgh Partners run 40% and 35% of the portfolio, respectively.) In addition to the fund's direct emerging-markets exposure, Lucas notes that the fund's managers own developed-markets names for their presence in emerging markets. The fund's Japan stake--at 23%--is also high relative to its peer group. The fund's idiosyncratic look can lead to volatility, but its combination of low costs and experienced management teams employing disciplined strategies argue in its favor.
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Christine Benz has a position in the following securities mentioned above: VTRIX. Find out about Morningstar’s editorial policies.