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Foreign fund insight
The best and worst of times for foreign funds
Except for the mutual funds scandal, foreign funds had a great year in 2003, often out-performing domestic funds. Does that mean you should pour money into foreign funds in 2004. Not necessarily.
By Emily Hall, Morningstar
It was a year of extremes.
The news surrounding foreign funds was generally very good last year -- with one grim exception: The fund industry was hit by a scandal that put foreign-fund pricing practices front and center.
When Eliot Spitzer announced that he was investigating several fund shops for allowing market-timing, it quickly became clear that foreign funds would be part of the storm. Janus, Nations Funds, Bank One, and Strong were all named in the initial complaint. And other firms fell under the scandal cloud later, including Putnam and its Putnam International Equity Fund (POVSX).
As we highlighted in a September "Foreign Fund Insight," foreign offerings that didn't employ fair-value-pricing policies were ripe for arbitrage efforts -- unless their parent firms employed other measures to keep out market-timers. More than ever, investors who want a foreign fund should emphasize those that discourage market-timing with short-term redemption fees, fair-value pricing systems, and a habit of ejecting shareholders who repeatedly break market-timing rules.
Foreign funds soared in 2003
Thankfully, investors in shareholder-friendly firms had lots to smile about in 2003. The foreign stock markets paced (and even surpassed, in some cases) the U.S. equity market. Indeed, the typical foreign large-blend fund gained 33% last year, while the average U.S. large-blend fund rose only 26%.
Rallies in both developed and emerging markets helped drive results in 2003. As a global economic recovery wobbled to its feet, bourses surged. Even longtime problem child Japan showed signs of potential -- and possibly sustainable -- economic growth. By the middle of the year, many managers, including George Greig of William Blair International Growth (WBIGX), expressed renewed interest in investing in Japan.
The most exciting growth prospects, however, came from the emerging countries, including large developing economies such as China, India, and Brazil. All three markets were major winners in 2003. Of course, the Yukos controversy in Russia late in 2003 served as a reminder that developing markets can fall sharply when political and economic systems run into trouble. Even with Russia's problems, however, the typical diversified emerging-markets fund gained a stunning 55% for the year.
The returns -- and the valuations (which were generally lower) -- overseas were too much to resist for some U.S. fund managers. Many domestic funds that invest a small portion of assets abroad -- like Columbia Acorn (ACRNX) -- ramped up their foreign exposure in 2003.
Foreign funds that did not hedge their currency exposure back into the dollar (the vast majority these days) also enjoyed a tailwind last year. For much of 2003, the dollar fell against most major currencies. The euro was one of the biggest gainers: It rose 20% against the dollar. Those few funds that hedge their currency exposure back to the dollar, like Tweedy, Browne Global Value (TBGVX), tended to suffer in 2003.
Fund strategy for 2004
So what's the upshot for you as an investor? Given the performance numbers in 2003 should you focus your efforts on finding a fund that can take advantage of a falling dollar and surging emerging markets? Not necessarily. In fact, chasing short-term performance numbers is usually a bad way to invest. Instead, look for one or two low-cost, diversified foreign offerings that employ straightforward investing strategies. (If you invest in two, you would probably want one of them to focus on large caps and the other to emphasize small and mid-caps.)
Moreover, many diversified foreign funds now invest 10% to 25% of their assets in developing markets, so you don't necessarily need to find a fund dedicated to emerging economies. For those who don't know where to start, our Fund Analyst Picks are a good place to begin your search.
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