(PUB) Investing 2016

11

July 2016

Morningstar FundInvestor

Funds Making Big Emerging- Markets Bets Red Flags | Alec Lucas

steep drop, but management was also mindful of the emerging-markets weighting of the MSCI All-Country World Ex- USA SMID Index, which became the fund’s new benchmark at the start of 2016 . Selling too late in a downturn didn’t help. Its 7 . 6% one-year loss through May 2016 ranks near the foreign small/mid-growth category’s bottom decile. Managers Louis Mendes and Zach Egan, however, have earned investors’ trust. They continue to use the same growth-driven and quality-oriented approach that has helped this fund to a peer-beating record since their May 2003 start date. Over the past year through March 2016 , Bronze-rated Manning & Napier World Opportunities EXWAX hiked its emerging-markets weighting by 10 . 3 percent- age points to 25 . 6% of assets, which was higher than 95% of its roughly 200 foreign large-blend cate- gory peers. The shift toward the developing world was not indiscriminate. The fund sold several emerging- markets stocks during that time ( Life Healthcare Group Holdings LHC and LATAM Airlines Group in June; Charoen Pokphand Foods in September; and Qihoo 360 Technology QIHU in November) and trimmed several positions. It added three names in such volume that the fund’s emerging-markets stake grew significantly: China’s Baidu BIDU (April) and Shandong Weigao Group Medical Polymer (May), and South Korea’s Samsung Electronics (November). By March 2016 , these three stocks accounted for 8 . 2% of assets. While the fund lost 9 . 2% over the trailing year through May 2016 , it still placed in the category’s top half. It has fared especially well in the emerging-markets rally since late January, though it’s vulnerable to another downturn. AMG Yacktman Focused Service YAFFX bought preferred shares of Samsung in 2015 ’s second quarter and added more in the third. Samsung is now the fund’s second-biggest holding. It and a modest position in China’s Hengan International Group account for the fund’s 12 . 4% emerging- markets stake as of March 2016 , which was the third- most out of 450 -plus large-blend category peers. The fund posted a top-quintile 1 . 8% gain over the past year through May 2016 , but neither Samsung

The recent emerging-markets bear market has left its imprint, at least in the short term, on the Morning- star 500 . Between the bear markets’ April 28 , 2015 , peak and its Jan. 21 , 2016 , trough, the MSCI Emerging Markets Index shed 34 . 1% of its value, with Brazil and China leading the race to the bottom. While their reasons for selling differed, two funds substantially cut their developing-markets footprints during that time and still got hammered. Two others had the temerity to buy in bulk, though only one benefited from the subsequent rebound through May 2016 . At the start of second-quarter 2015 , Artisan Interna- tional Small Cap ARTJX had a 31% emerging- markets stake (including South Korea and Taiwan), ranking second out of roughly 40 foreign small/ mid-growth Morningstar Category peers and was 13 . 4 percentage points more than the MSCI All-Country World Ex- USA SMID Growth Index. More than four fifths of that exposure, though, was concentrated in seven Chinese stocks. One year later, longtime manager Mark Yockey had sold all of them, with most of the selling taking place in 2015 ’s fourth quarter. Some of these stocks had been big winners for the fund in prior years. China Oil & Gas Group , however, proved costly; it was a big loser while the fund held it. Through May 2016 , the fund’s 6 . 6% loss over the past year trails the benchmark by 3 percentage points and places in the category’s bottom quintile. Short- term underperformance is to be expected here, though. Yockey goes his own way in managing this closed fund’s roughly 35 - to 50 -stock portfolio, and he’s built a superior long-term track record doing so. Between June and December 2015 , Columbia Acorn International ACINX , with a Morningstar Analyst Rating of Silver, slashed its emerging-markets expo- sure by 13 . 2 percentage points to 17 . 8% of assets, near where it has remained since. Deteriorating funda- mentals and underperforming small caps drove the

What is Red Flags? Red Flags is designed to alert you to funds’ hidden risks. Such risks can take many forms, including asset bloat, the departure of a solid manager, or a focus on an overhyped asset class. Not every fund featured in Red Flags is a sell, and in fact, some are good long-term holdings. But investors should be prepared for a potentially bumpier ride in the near future.

nor Hengan drove that outperformance. K Contact Alec Lucas at alec.lucas@morningstar.com