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How Slumping Emerging Markets Affected Your Foreign-Stock Fund Morningstar Research | Gregg Wolper

Given how poorly emerging markets performed over the 12 -month period, one might have expected all of these funds to have finished in the bottom quartile of their respective categories. As it turned out, the results were much more varied, with the funds distrib- uted fairly evenly throughout the percentile rankings. Examining the reasons shows how evaluating fund performance can be more challenging, but also more interesting, than one might suspect. Of the group, the worst performer was Virtus Foreign Opportunities JVIAX . That fund’s manager, Rajiv Jain, has also run emerging-markets portfolios for many years and thinks that tremendous opportuni- ties can be found there, most notably in India. So it’s no surprise to see an emerging-markets stake of 14% in that fund. It’s also no surprise to see that it sat nearly at the bottom of the foreign large-growth category during this period. What makes things interesting, though, is that the fund’s emerging-markets stake was not the only culprit; it may not even have been the most important. In fact, that stake is just a bit above the foreign large-growth category average. More critical was that Jain has invested very sparingly in Japan for years, saying that tempting growth companies at appealing prices are few and far between in that country. With Japan posting by far the biggest gains among developed markets in 2013 , that lack of exposure— the most recent portfolio had just 1% of assets in Japan, versus a category average of 12% —held the fund’s returns back in relative terms. The story at Janus Overseas JAOSX , which landed near the bottom of the foreign large-blend category, is different in one way but similar in others. With more than 40% of assets in emerging markets, this fund has much more exposure than the Virtus offering, and there can be little doubt that that played a substan- tial role in its underperformance during this period. However, there’s more to the story here as well. Manager Brent Lynn also had a big overweighting in energy stocks—some in emerging markets, some not—and that caused much pain as that sector stum- bled. Like Jain’s fund, this one also was hurt by going light on Japan, though not to the same extreme as

After years of outperforming the established markets in Europe, the United States, and other developed countries, emerging stock markets have hit some bumps. Concerns about the slowing growth rate in China and many other countries, along with poli- tical worries in Brazil, Turkey, Russia, and elsewhere, have weighed on these markets. The disparity between equity performance in devel- oped versus emerging markets became pronounced in 2013 and early 2014 . In the 12 -month period through January 2014 , the MSCI Emerging Markets Index suffered a loss of 10 . 2% , in sharp contrast to the MSCI EAFE Index of developed markets, which rose 11 . 9% . Given that 22 -point gulf, we thought it would be useful to look at the performance of the core interna- tional funds in the Morningstar 500 (those in the three foreign large-cap categories) that had substan- tial emerging-markets stakes to see how their performance stacked up. The results are not quite as one might expect and are all the more instructive for that. A Varied Impact Of the 35 foreign large-cap funds in the Morningstar 500 , only nine (excluding index funds) had emerg- ing-markets stakes of greater than 13% of assets as of their late- 2013 portfolio. (That figure was chosen because it’s higher than the average emerging- markets stake for any of the three foreign large-cap categories.) This figure excludes investments in South Korea and Taiwan, which are classified as emerging markets by MSCI but not by Morningstar and some other services. If those countries were included, the numbers for the emerging-markets stakes would be higher, but the overall pattern would look much the same.