In the event you haven’t noticed, international stocks are significantly outperforming U.S. stocks so far in 2015, but something you may not have noticed is if your international stock fund is keeping up with its benchmark index or category peers. And if it’s under-performing, what’s the reason?
In an environment of moderating economic growth with a strong dollar, like the one the U.S. is in now, foreign stocks generally outperform domestic.
Yet, not all international stock funds allocate 100% of assets to non-U.S. stocks, and if your international stock fund holds U.S. stocks, the performance in 2015 is likely to be behind the category averages and/or a benchmark like the MSCI EAFE Index, as tracked by the iShares MSCI EAFE ETF (EFA).
Therefore, your international stock fund may be falling behind the index or category averages this year because its not “international enough.” This is a portfolio management problem I see quite often. Investors often look at the surface of performance but fail to look underneath the hood at the holdings.
International Stock: What’s in a Name?
The word international is an adjective that describes something that occurs between two or more nations. In simple terms, a mutual fund that invests 50% of its assets in U.S. stocks and the other 50% in European stocks could be defined as an “international stock fund.”
In mutual fund nomenclature, a fund that invests in stocks from several or dozens of countries around the world is usually called “foreign stock.” For example, one of the largest world stock funds is American Funds Smallcap World (SMCWX), which recently held nearly 46% of its assets in U.S. stocks.
What’s the problem with that? Nothing. But if you’re trying to add non-U.S. stocks to your portfolio, you’re only doing a partial job of it with SMCWX.
In general, most funds do a good job of staying true to their stripes when it comes to international stock funds. For example, Dodge & Cox International Stock (DODFX) recently held more than 86% non-U.S. stocks. DODFX is categorized as a “foreign stock” fund, which usually means at least 80% of holdings are non-U.S. stocks.
Avoid International Stock Confusion
In the previous five calendar years, 2010 through 2014, U.S. stocks vastly outperformed non-U.S. stocks. The international stock funds with U.S. stocks in them have generally outperformed those with 100% international stocks.
Now that foreign stocks are leading U.S. stocks in 2015, the opposite is happening: The international stock funds with U.S. stock holdings are falling behind the index and category averages.
For example Oakmark Global Select (OAKWX), which recently held approximately 52% U.S. stocks, beat the iShares MSCI ACWI ex U.S. ETF (ACWX), which is 100% foreign stocks, for five consecutive years. But now that the foreign stocks are beating domestics in 2015, OAKWX is losing to the ACWX.
As you might imagine, cash flows tend to follow performance. How many investors bought OAKWX in recent years because they wanted to buy a top-performing international stock fund? Well, by definition, OAKWX is “international,” but most investors were really looking for “foreign stock.” Now that the fund is falling behind the index and category average, will investors dump OAKWX?
There are two ways to avoid international stock confusion:
- Check the portfolio holdings: Most mutual fund research sites provide data on holdings and the percentage of U.S. stocks and non-U.S. stocks. You can also find this information in the fund prospectus or online fund summary, which will usually say how much foreign stock the fund’s objective says it will hold at a minimum.
- Buy index funds: Actively-managed funds can be an advantage with foreign stocks, but the best way to be sure you’re getting a fund that will remain true to its stripes is to buy a foreign stock index fund or ETF. Just be sure you use the correct index! For example the MSCI ACWI Index includes all countries in the world with open capital markets, including the U.S. Instead find a fund that tracks the MSCI ACWI ex-US Index or the MSCI EAFE Index.
What’s in your international stock fund?
As of this writing, Kent Thune did not hold a position in any of the aforementioned securities. However, he holds DODFX in some client accounts. His No. 1 holding is his privately held investment advisory firm. Under no circumstances does this information represent a recommendation to buy or sell securities.
