It’s the Right Time to Invest Overseas. Here Are the Best Funds to Do It.

But Brooker and his co-managers have ways of defending their investors. For one, First Eagle Global is flexible enough to invest anywhere globally—including the U.S.—that they think will produce the best returns with the least downside risk. The fund’s secret sauce, though, is its 11% allocation to gold bullion. “If you look at how gold’s traded over the past century, it has tended to have its best decades when equities have had lost decades,” Brooker says. “It’s a potential hedge.” The fund fell only 6.5% in 2022 during an inflationary environment that favored gold, while the EAFE index lost 14.5% and the S&P 500, 18.1%.

Given that 2023 looks to be just as volatile—even if we’re past the worst of the recent banking crisis—investors need a smoother ride. Understanding how a fund generates its returns isn’t enough. You should know what its risk-control strategies are, and whether they’ll work now. This is especially so if you’re considering investing in foreign markets, which have additional currency, geopolitical, and economic risks.

And if you aren’t considering foreign-stock funds now, you should be. Having some foreign-stock exposure is a smart asset-allocation policy—and valuations are cheap overseas, so it’s a good time to add that diversification.

Playing the Trends

Every decade or so, emerging markets tend to outperform the U.S. In the most recent period, the end of 2010 through 2022, the S&P 500 was up 355% and emerging markets only 26%, managers Laura Geritz and Blake Clayton of the

Rondure New World

fund (RNWOX) point out in a white paper published in January. In the period right before that, 1999 through 2010, emerging markets were up 392% and the S&P 500 10%.

A larger reversal may have already begun. Since Oct. 12, when many developed markets bottomed, through March 31, the

iShares MSCI EAFE

exchange-traded fund (EFA) is up 28%, including dividends, while the S&P 500 has gained only 16%. The

iShares MSCI Emerging Markets

ETF (EEM), which bottomed on Oct. 24, is up 18% versus the S&P’s 9%.

Foreign value stocks are especially cheap. The MSCI EAFE Value index had a 9.6 forward price/earnings ratio as of Feb. 28 versus the MSCI EAFE Growth’s 24.7 P/E, an extremely wide gap. The MSCI USA Index, which is similar to the S&P 500, had a 20.8 P/E, and MSCI USA Value, 15.5.

“Value has started to outperform growth in the past few quarters, but we are still at extreme levels of dislocation,” says co-manager Mark Costa of

Brandes International Small Cap Equity

(BISAX). The fund trades at a 37% discount to its average company’s book value, a 0.63 price/book ratio, which is one-fifth of the S&P 500’s 3.3 ratio, according to Morningstar.

The currencies that Costa’s stocks trade in, such as the euro and the yen, hit multidecade lows last year against the U.S. dollar. Both a value and currency recovery will act as double tailwinds to his fund.

Although cheap now, foreign currencies always add to a fund’s volatility, and by hedging their currency exposure, a number of funds have provided more consistent returns.

“When we [launched] this international value fund in the summer of 1993 and decided to invest outside the U.S., that presented an additional currency risk, which, in our view, was quite unmanageable,” says Bob Wyckoff, a manager of the currency-hedged

Tweedy Browne International Value

fund (TBGVX). “We looked at empirical data for hedged and unhedged international indexes over long periods, and it was clear that you didn’t make money simply being exposed to foreign currency. You had to be able to trade it very successfully.”

Wyckoff’s fund has a standard deviation, a volatility measure, of 11.8% in Morningstar’s Foreign Large Value fund category over the past 10 years, versus the average fund’s 16.1%.

It has also had a low downside capture ratio of 68% during this period versus its benchmark, which means that for every 1% foreign markets fell on down days, it was down only 0.68%, versus the average category fund’s 1.02%.

Low-cost ETFs like

iShares Currency Hedged MSCI EAFE

(HEFA) also offer currency hedging. If volatility is a primary concern, such a fund makes sense. If, however, you want to take advantage of historically cheap euros and yens, now could be a good entry point for unhedged funds.

Quality Tilt

While Tweedy’s team pays close attention to valuations, it doesn’t usually buy deep-value stocks of distressed companies. Rather, it seeks high-quality companies with strong balance sheets and defensible business models that are suffering temporary dislocations in their businesses.

One recent purchase typical of Tweedy’s style is

Alten

(ATE.France), a French engineering-consulting company. “If

BMW

were to design a new car, it would need extra engineers, but it wouldn’t need them forever,” says Andrew Ewert, another Tweedy manager. Recessionary concerns drove the stock down recently, but over the long term, the need to outsource engineering is growing.

Quality can be a nebulous term for fund managers, but it often includes companies with low—or at least manageable—debt levels. This is especially important in today’s rising interest-rate environment, which increases interest burdens. Tweedy scrutinizes repayment schedules as well as aggregate debt. If a company has debt expiring soon, it could mean it has to issue new, more costly debt at higher rates.

FMI International

(FMIJX) employs a similar high-quality, valuation-conscious strategy that is currency hedged. “We try to win by not losing,” says Jonathan Bloom, one of FMI’s managers. “You can largely do this by avoiding poor, low-quality businesses, and by being very disciplined on valuation.”

Minimizing Volatility

The likelihood of a business going bankrupt or suffering a “permanent impairment of capital” is a greater risk to managers like Bloom than stock volatility itself. Yet there are quantitative “smart beta” funds that make volatility reduction their primary goal. The

iShares MSCI EAFE Min Vol Factor

ETF (EFAV), for instance, buys the stocks with the least volatility in the EAFE benchmark and tries to optimize their weightings to reduce volatility overall. The

iShares MSCI Global Min Vol Factor

ETF (ACWV) does the same thing globally.

The problem with low-vol funds is they rely on backward-looking data, presuming that a stock with low volatility in the past will remain so in the future. Low-vol strategies can malfunction at inflection points when sector or stock leadership shifts.

“It’s very difficult to invest consistently in a low-vol strategy because, quite often, you’re investing in the lowest point of historical volatility in companies that may be at extremes in their [performance] cycle,” says Gerald Du Manoir, a manager of

American Funds International Vantage

(AIVBX). He points to utility stocks, which, because of their healthy dividend yields, behave like bonds. As such, they tend to be low-volatility and consistent performers when interest rates are stable or falling, but high-volatility when rates are rising.

Diversification

The right amount of diversification is essential for risk reduction. Too little, and one company’s collapse is devastating. Too much, and an active fund becomes a high-cost closet indexer. Generally speaking, the larger the companies a fund invests in and the higher the quality of those companies, the less portfolio diversification is necessary, as larger companies are more resilient to economic downturns and more diversified in their customer bases and business lines.

First Eagle Global typically invests in about 100 or more stocks of all capitalizations. “Managers often argue you only need 20 or 30 stocks to get statistical diversification, but we have the humility to accept uncertainty,” Brooker says, referring to unexpected negative events or what Wall Street calls “fat tails” that can impact even the highest-quality business.

Still, the blue-chip FMI International fund has typically managed to hold between 20 to 40 stocks while maintaining a low-risk profile.

Small-Caps

It’s when you go down the quality and capitalization ladder that broader diversification becomes essential. Part of the issue with foreign small-caps is liquidity, as they are harder to trade.

Fidelity International Small Cap

(FISMX) currently holds about 190 stocks. “All else equal, I would like to run [the fund] with fewer names,” says the fund’s co-manager, David Jenkins. “But I have to balance that against liquidity for our shareholders and not taking too much risk.” Jenkins has managed to have less downside and volatility than his peers, but more than large-cap low-risk funds, as expected.

Yet some of the best opportunities today are in foreign small-caps. The MSCI ACWI ex USA Small Cap Index has over 4,000 stocks for active managers to find bargains. “Wall Street doesn’t cover these companies,” says Costa. “There aren’t a lot of active managers looking at them.”

Consequently, Costa can find diamonds in the rough—like one recent purchase,

Grifols

(GRFS), a Spanish healthcare company specializing in blood plasma therapies. “When the economy weakens, people are more likely to go support their income through blood donations,” he says. “But Covid basically shut down Grifols’ ability to collect plasma.” Costa sees that as a temporary phenomenon.

Brandes’ small-cap fund is more deep-value-oriented than Fidelity’s, so it should outperform in a market that favors value stocks, but lag behind when growth is popular. The Brandes fund has had a better downside capture ratio than Fidelity’s in the past three years as value has recovered, but a worse one than Fidelity’s in the past 10.

Emerging Markets

Perhaps the most difficult risk foreign-stock managers have to face is country risk—when an entire nation’s economics, politics, or regulations could become unfavorable to investors.

Most managers are “bottom up” stockpickers who consider country risk as an afterthought. Yet risks increase in emerging markets, which often have unstable political regimes and sometimes fragile economies. “Most of the volatility that you incur is country-driven,” says manager Andrew Foster of

Seafarer Overseas Growth and Income

(SFGIX), a top-performing emerging markets fund. “If I could allocate my portfolio based on a macro insight about which country is going to blow up next, I absolutely would. But I have yet to see anyone in the industry do so consistently in a way that’s indistinguishable from luck over time.”

Although Foster can’t predict country blowups, he does react to warning signs. He has, for instance, largely minimized his China exposure in recent years because of its authoritarian regime. But mostly, he tries to diversify his country and sector exposure and buy high-quality companies with businesses that are less dependent on the vagaries of their home nations.

Dividends

One key evidence of quality for Foster is a company paying a stable dividend. “I can verify that the cash flow really exists, that it’s liquid enough, and that the company’s solvency is high enough that it can share some of that cash flow with me on a regular basis,” he says.

While Foster currently favors reliable dividend payers like Korean auto-components maker

Hyundai Mobis

(012330.Korea), other top emerging markets managers, such as Brian Kersmanc of

GQG Partners Emerging Markets Equity

(GQGPX), have been feasting on the double-digit dividends of Latin American oil stocks like Brazil’s

Petrobras

(PBR), which paid $6.45 a share in dividends in 2022.

Rondure New World’s Clayton also favor dividend payers, citing low valuations, consistent dividends, and strong balance sheets as “the three great commandments of downside risk protection.”

There are also dividend-oriented ETFs, such as

Vanguard International Dividend Appreciation

(VIGI) and

WisdomTree International Hedged Quality Dividend Growth

(IHDG), that have proved low-risk long term, though emerging markets ETFs have mixed records.

If, after considering the risks, you’re still too frightened to buy an overseas-only fund, consider a good go-anywhere global allocation one such as First Eagle’s, or a low-vol global stock one like the iShares ETF. They’ll get you foreign exposure while letting you sleep at night.

Email: [email protected]