With global stocks wobbling this year, it may be tempting to look for stability and safety close to home. For long-term investors, however, this may be a prime time to swoop in and add some foreign funds to your portfolio.
Foreign stocks tend to trade at a discount to the U.S., and that discount has widened in recent years as U.S. stocks have surged, outperforming their foreign counterparts.
European stocks are now 13% cheaper than the U.S. when comparing stock prices to forecast earnings, while Japanese stocks trade at a 9% discount, according to index provider MSCI. Emerging markets are even cheaper, trading around 40% below developed-market stocks, the deepest discount in eight years, according to BlackRock chief investment strategist Russ Koesterich.
"International markets are significantly cheaper across all metrics,'' says Jed Weiss, manager of the Fidelity International Growth Fund (FIGFX). "They're also somewhat less efficient markets [than the U.S.] and provide better opportunities for stock pickers."
Foreign stocks are on sale for a reason. Europe's economy is growing less than 1% a year. Japan faces a host of economic woes that could pressure corporate profits. And emerging markets are being battered by a slowdown in China, weaker currencies and fears of slower growth.
Yet some analysts argue these issues are now reflected in the discounted prices of foreign stocks.
"The U.S. market has been on quite a run and that's made many investors doubt the benefits of foreign investing,'' says Paul Jacobs, chief investment officer for Scarsdale, N.Y.-based financial planning firm Palisades Hudson. "But the U.S. can't outperform forever."
Ideally, Jacobs recommends that long-term investors hold 35% of their stock portfolios in foreign stocks, diversified globally.
Because international stocks don't move in lockstep with domestic stocks, adding some foreign exposure to a portfolio of U.S. stocks can reduce risk and boost returns.
Indeed, from 1997 to 2013, a portfolio of global stocks beat a U.S. stock portfolio by an average of two points a year, according to a study by investment firm Gerstein Fisher.
To find compelling fund choices, we asked Lipper to screen for top-performing no-load funds in the major non-U.S. stock categories over the past five years. In addition to strong returns, we sought funds with reasonable expenses and experienced managers with a consistent investment approach.
Here are five funds to consider, based on the results of the Lipper screen. These are not recommendations but rather ideas for further research. And remember: Foreign stock investments pose currency risks, can be highly volatile, and should be used as part of a well-diversified portfolio.
Madison NorthRoad International Fund
- Ticker symbol: NRIEX
The managers of this fund now see the biggest bargains in Europe and the United Kingdom, where they hold 85% of the fund's investments.
Top holdings like beverage company Diageo (DEO) and electrical equipment maker Schneider Electric (SBGSF) have been punished for being domiciled in Europe, says co-manager Jim Shore. Yet they're solidly profitable and have long-term growth potential. "We're not buying distressed assets or beaten up companies requiring massive reorganization," he says.
Sticking with high-quality stocks has helped the fund's volatility stay below-average, according to Morningstar, while its returns beat 85% of rivals over the past five years.
Key risks: The fund is mainly a play on a rebound in European markets, which could slump if the region's economy doesn't pick up.
Matthews Asia Growth
- Ticker symbol: MPACX
The price of admission to this fund is annual earnings growth of 15% to 25%. Companies must also have "pricing power" and plenty of cash flows to expand their business, says lead manager Taizo Ishida.
The fund now favors stocks catering to the Asian consumer like Sands China (SCHYY), a leading casino operator in Macao, and Japanese automakers Toyota (TM) and Honda (HMC).
Overall, returns have averaged 19.2% over the past five years, beating 96% of Pacific/Asia funds, according to Morningstar.
Key risks: The fund's focus on the Far East could be a detriment if Asian markets slump.
Fidelity International Growth
- Ticker symbol: FIGFX
As manager of this fund, Weiss looks for a few key attributes in a stock: multi-year growth, high "barriers to entry" and a compelling entry point.
Many stocks that pass his tests can now be found in Europe. Top holdings include big global names like Roche (RHHBY), Nestle (NSRGY) and Prudential PLC (PUK). Weiss also sees opportunities in Japan, including technology companies he says are harnessing the same trends driving U.S. tech stocks, but trading at cheaper prices.
"Japan is one of the few corners of the world where stocks can go up 50% and still be ridiculously cheap," he says.
Key risks: Weiss holds 14% of the fund's investments in U.S. stocks and performance could lag pure-play foreign rivals if the U.S. market falters.
Northern Multi-Manager Emerging Markets Equity
- Ticker symbol: NMMEX
Emerging markets are highly volatile, but they offer exposure to some of the world's fastest growing regions and companies. Active managers can avoid the trouble spots, moreover, finding investments that still look attractive.
That's the goal of this fund which splits its investments into five sleeves, each run by a separate sub-adviser. Around 30% of the fund is dedicated to growth stocks, 30% to value and 20% to "opportunistic" situations. The idea is to cover the full spectrum of investment styles and to capture the best mix of risk and return, says co-manager Christopher Vella, who oversees the fund.
The setup places greater emphasis on stock picking than conventional country allocations. And it has fared well: The fund returned an average 16.3% over the past five years, compared to a 14.8% average return for the MSCI Emerging Markets Index.
Key risks: The fund has a strong value tilt that could cause it to lag if growth stocks outperform.
Oakmark International Small Cap
- Ticker symbol: OAKEX
Small-cap stocks are risky, and it can take patience to make money. Yet investors who stuck with this fund have been rewarded: the fund beat 97% of rivals over the past five years, according to Morningstar.
Leading the fund is David Herro, a highly disciplined international stock picker who only buys a stock if it's trading at least 40% below his assessment of "fair value." He then waits patiently for the stock to appreciate and trims exposure as it becomes more fully valued, plowing the gains into cheaper stocks.
"It's a contrarian approach and can take a while for the strategy to play out,'' says Morningstar analyst Shannon Zimmerman. Indeed, the fund has trailed the Lipper International Small Cap Fund Index over the past three years by about 0.6 points. Still, Zimmerman recommends the fund for long-term investors, arguing it "remains a strong option for exposure to smaller-cap foreign stocks."
Key risks: A run up in small caps over the last several years has made valuations less compelling and lowered potential for high returns.
Mark McLaughlin is a contributor to Fidelity Interactive Content Services, a provider of objective investing content on Fidelity.com. He does not own any of the securities mentioned in this article.