WHILE U.S. MARKETS CAPTURED THE HEADLINES DURING THE 1990s, foreigners are leading in this decade. For the past four years, the Standard & Poor's 500 stock index has trailed the Morgan Stanley Capital International EAFE benchmark. But not all foreign funds have shared equally in the good times. As in the U.S., value has clobbered growth. Beginning in 2000, foreign large-value funds led foreign large growth for five consecutive years, according to Morningstar. Now that may be changing. During the second half of 2005, growth funds surged ahead.
There is good reason to expect that growth stocks will continue shining overseas. While foreign stocks are generally cheaper than their U.S. counterparts, growth seems to offer special bargains. The average foreign large-growth portfolio has a price-earnings ratio of 17.4, compared to 20.5 for domestic competitors. The foreign funds could get a particular boost from Asia and emerging markets, where economic growth is strong and consumers are eager to shop for cars and other goods that they could never afford in the past.
Which foreign large-growth vehicle could provide the best ride? To narrow the field, Wealth Manager turned again to the eight-part screens developed by Donald Trone, CEO of FI360 in Sewickley, Pa. The due diligence process seeks to find funds that have more than $75 million in assets and are at least three years old. At least 80 percent of holdings must be consistent with the category, and the expense ratio must fall below the top quartile. One- and three-year returns must exceed the category's median, as must five-year results, if the fund is that old. Alpha and Sharpe ratios must also surpass the category's median.
The screens reduced the choices from 193 contenders to 7. The finishers with the strongest five-year performance records--Fidelity Diversified International and William Blair International Growth--are both closed to new investors. Other strong choices were AIM International Growth and Janus Overseas. But the title went to Laudus International MarketMasters I, the top performer that was still open.
Laudus produced a winning record by staying diversified, holding about 400 stocks. The assets are divided among four subadvisors, including three growth managers and one value specialist. The aim is to maintain a broad mix that will hold up in a variety of market conditions. Most often, the fund has succeeded, outperforming competitors in down markets and producing winning results in good times. Laudus portfolio manager Jeff Mortimer aims to find subadvisors with long records of producing consistent results. He has selected two of the best-known names in the large growth category--Mark Yockey, manager of Artisan International, and George Greig of William Blair International Growth. The subadvisor team also includes David Herro of Oakmark International, who oversees the value picks, and Federico Laffin of American Century International Opportunity, a small-growth specialist. To avoid overlapping holdings, Mortimer carefully selects managers that follow different disciplines. While Yockey focuses on European blue chips, Greig roams around the world, holding sizable stakes in emerging markets and a big position in midcaps.
To boost returns, Mortimer shifts assets among his managers, increasing allocations to areas of the market that seem most promising. The fund is free to shift its portfolio to the blend box, but for the past three years, Laudus has landed under the growth heading. At the moment, the fund has 62 percent of assets with growth managers and 38 percent in the value camp. Mortimer expects to maintain the growth bias. He says that the economy is beginning to slow, an environment that will favor companies with growing earnings. "As growth in earnings becomes harder to find, investors will pay a premium for companies that can deliver improving results," he says.
While the fund currently has 12 percent of assets in small stocks, Mortimer expects to lower that figure soon to 5 percent or so. After leading the markets for six years, small stocks are becoming expensive, he says.
Seeing the roster of all-star subadvisors recruited by the fund, some investors might consider bypassing Laudus and investing directly in the managers' flagship vehicles. But that could be difficult; flooded with assets, most of the flagships are closed to new investors, including funds from American Century, Oakmark, and William Blair. "We provide access to managers who may be hard to reach any other way," says Mortimer.
The subadvisors are willing to accept more cash from Laudus because it is a reliable account, Mortimer adds. He talks to his subadvisors regularly, determining when they can accept more cash. "There are no surprises," says Mortimer. "We are not like retail customers who may suddenly pull in or out of a fund."
Mortimer monitors his subadvisors constantly. He can fire managers, but he is slow to pull the plug. After Mark Yockey lagged competitors in 2003, Mortimer held on and was rewarded with a healthy showing in the next year. In 2005 the American Century team lost one of its two co-managers. Mortimer notified the subadvisor that he would review the change. After six months, he decided to keep the subadvisor, concluding that the remaining manager was maintaining his discipline and delivering strong results.
If the performance of Laudus attracts more assets, the fund will have to add more subadvisors, Mortimer says. But for the moment, he is content to patiently monitor his current managers, allowing them to follow the disciplines that have delivered winning results.
Stan Luxenberg (firstname.lastname@example.org) is a business writer and regular contributor to Wealth Manager.