2 Top Specialized Foreign Stock Funds

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Investors may be tempted to give up on their foreign-stock holdings, but Morningstar's director of Manager Research Russ Kinnel says not so fast. He is here with me today to share two favorite more-specialized foreign-stock funds.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, let's just start by talking about the thesis for making sure that I hold, and that investors hold, foreign stocks in their portfolio. They've performed a bit better recently, but I think that some investors might be looking like at 10-year returns and might be pretty tempted to, if not cut their foreign-stock holdings, at least maybe not top them back up. Let's talk about the case for international diversification.

Kinnel: Foreign equity is about half of the overall global market cap. But if you look at history, we see that generally the U.S. takes a turn leading and then you might go two decades where other markets are leading. And so, you are really giving up a lot of diversification and just a lot of good companies, a lot of great companies outside the U.S. So I think most people are better off with a meaningful exposure to foreign equities.

Benz:We're going to be talking about some more-specialized foreign-stock funds. Let's just do a little bit of stage-setting on that. Before I consider funds like the ones we'll talk about, I probably want to make sure that I have something big and broad supplying foreign-stock exposure first.

Kinnel: That's right. These are foreign small- and mid-cap funds that I'm going to recommend. But right, first take care of that core and make sure you've got some foreign large-cap names. These small- and mid-caps are probably better no more than, say, 10% of your portfolio. I really wouldn't make it a huge position, but I do think they are valuable diversifiers.

Benz:Let's start with one that is a foreign small-mid blend fund. It's Bronze-rated. This is FPA International Value. It might be not so familiar to some of our viewers, so let's talk about why you like it.

Kinnel: It's a small fund, only about $250 million. We only recently upgraded it to Bronze. It's run by Pierre Py, who came from Harris Associates which runs Oakmark. If you know Oakmark International, you'll recognize some of the characteristics here, focus on stocks trading at a big discount to intrinsic value, concentrated portfolio. It's a little different though in that it's got more in cash and it's smaller in market cap, though it doesn't have any market-cap restrictions. But what we like about it is, he has really demonstrated he is a good equity manager. At first we were a little wary of the fund because when he came on board in 2011, there was some turnover in personnel, but that stabilized and so has the portfolio, and now it's a pretty appealing fund.

Benz:At the growth side of the Style Box a fund you like is Artisan International Small-Mid Investor. This lands in the foreign small- and mid-growth category. It too is rated Bronze. Let's talk about that one.

Kinnel: This fund has changed completely. The firm brought in Rezo Kanovich from Oppenheimer International Small-Mid and now it's a very aggressive growth fund. So, he did a tremendous job at Oppenheimer with large sum of money. Now, he is running about $600 million at Artisan. So, he has got a smaller asset base to manage which I love, but he really did a tremendous job with kind of theme-driven growth investing. So, I think it's a really appealing fund to get in on right now. But it is aggressive, so – I already mentioned earlier, don't go nuts with a big weighting. This is definitely a fund I would not put over 10% of my portfolio in.

Benz: Right-size the holding size. You mentioned a couple of times, Russ, the importance of size to you when you think about products like these that focus on small- and mid-cap stocks. Let's talk about why that's a consideration. If it's a very large-cap fund, you don't need to worry so much. But once you are looking at something that focuses on smaller stocks, why you should care about that?

Kinnel: Well, I think smaller caps can be more volatile. You would hate to miss out if there is a big large-cap rally. You'd hate to miss out simply because you are in small. In the case of these two particular funds, they each have reasons that make me think they will continue to be volatile. One is a focused fund; the other is a very aggressive growth fund. So, put all that together and I think it makes sense to manage your risk by keeping position size small. That's probably the easiest and best way to do it.

Benz: I know that we tend to think highly of those firms that watch asset growth, too, that aren't just taking in all the assets that they can, that actively manage asset size and close funds preemptively.

Kinnel: That's right. Both Artisan and FPA have a pretty good record of closing funds. So, I think in both of these cases, if they are successful, I would imagine they will close at a fairly good point, so that the managers can keep doing what worked all along.

Benz: Sounds like a worthy short list of funds, worthy of further investigation. Russ, thank you so much for being here.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.