(PUB) Morningstar FundInvestor

April 2 014

Morningstar FundInvestor

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Virtus Foreign Opportunities. Meanwhile, one of Lynn’s most highly weighted emerging-markets stocks— Ctrip CTRP , the Chinese online travel firm— actually scored a huge gain for the fund. On the happier end of the spectrum lies Dodge & Cox International Stock DODFX . Its 17% stake in emerging markets is more than double the foreign large-blend category average of 7% . Yet the fund’s returns landed in the 12 th percentile of the cate- gory during the period in question. One explanation is that more than 6% of the fund’s assets were in South Africa, with most of that devoted to one stock— Internet firm Naspers —that posted a tremendous gain in this stretch. Longleaf Partners International LLINX also man- aged to rack up a very strong return, landing in the foreign large-blend category’s top decile, even though it held a double-digit percentage of assets in emerg- ing markets. Here, the answer is that this fund owns a very compact portfolio of about 20 stocks, so to an even greater degree than Dodge & Cox International, its “emerging-markets stake” really comes down to a few specific companies. One with a hefty weighting in the portfolio is Melco International Develop- ment, a casino company focused on Macau, and that stock soared more than 200% in 2013 . As a result, far from holding it back, this fund’s emerging-markets exposure actually propelled its gains. Effects on the Index Funds The emerging-markets effect did clearly boost the fortunes of two Morningstar 500 funds in the foreign large-cap categories, in relative terms at least. These are the index-trackers with portfolios that are almost entirely free of emerging-markets exposure: Fidelity Spartan International Index FSIIX and Van- guard Tax-Managed International VTMGX , which track different developed-markets indexes. Without emerging markets dragging them down, both funds landed in the 28 th percentile of the foreign large- blend category over this period. The effect is illustrated most clearly by comparing the 11 . 5% return of these two funds with the return of Vanguard FTSE All-World ex-US Index VFWAX ,

which tracks a large-cap index very similar to those of the Vanguard and Fidelity funds above—but with a 14% stake in emerging markets. It gained only 5 . 3% , less than half the return of the emerging-markets-free index trackers. Conclusion Two main points emerge from this examination. One is that investors should be aware of the emerging- markets exposure of their funds before buying them and definitely as they continue to own them. There’s no telling whether emerging markets as a whole will outperform more-developed markets during any particular time period. But knowing how a fund is positioned in that respect will reduce the chance of surprises for shareholders. The second point is that such a check makes up just part of the evaluation process. As shown, even when the performance of emerging markets lagged that of developed markets by a startling margin, funds with relatively high emerging-markets stakes could still outperform. That’s because many other factors also play a role in performance, including sector weightings, currency exposure, and, most crucially at times, which individual stocks the man- ager has chosen. The decision on how much to allot to each company also plays a role: A fund with 8% of assets in a stock that tanks will be affected much more than one with just 1% in the same stock. Finally, even the emerging-markets weighting itself can be an imperfect guide. The countries gathered under that banner differ from one another in many ways, and often their stock market performance does, too. Funds with the same emerging-markets weight- ing could experience a very different impact depend- ing on which markets are represented. In short, emerging-markets weighting is just one factor among many that affect the performance of international funds—and a complex one, at that. œ Contact Gregg Wolper at gregg.wolper@morningstar.com