2 down-but-not-out foreign funds

By Morningstar

Foreign-stock funds are facing challenging conditions in 2008. The United Kingdom, Japan, France and most other developed markets have dropped 10% to 20% because of credit troubles, rising inflation, reduced consumer spending and worries about a global recession.

Most emerging markets have incurred similar or even bigger declines as they have been hit by many of the same problems and a variety of local issues.

And most of the scattered, resource-heavy markets that shone early in the year as commodity prices soared, including Russia, Canada and Brazil, have fallen significantly in recent weeks as oil and other materials stocks have slipped. As of early August, they were under water for the year.

There have been fewer and smaller pockets of strength in this year's worldwide sell-off than in many previous global downturns. Nearly all sectors are deep in the red, and financials -- the biggest sector, with more than one-fourth of the universe of overseas stocks -- have suffered the most.

The health care sector, which has been the most resilient one this year, is barely in the black, and it's a relatively small part of the overseas universe. Only 7% of the MSCI World ex USA Index is made up of health care stocks. (MSCI stands for Morgan Stanley Capital International, which maintains a number of indexes. You can check them out here.)

And international stocks from all over the market-cap and style spectrums have struggled in 2008.

Not surprisingly, suffering has been widespread and severe among foreign-stock funds. The five style-box-based foreign-stock categories contain 443 distinct portfolios that have been around since the start of 2008 or longer, and every one of them has lost 6% or more in 2008.

The averages reveal the extent of the damage to foreign-stock funds:

• The large-value, large-blend and large-growth categories have all declined around 16% this year.

• The average small/mid-value fund has done the same, and the typical small/mid-growth fund has fallen somewhat more that.

Because of the breadth and depth of this year's foreign sell-off, we thought it would be worthwhile to examine some previously successful funds that have held up well in 2008 and some that have really struggled. Below we evaluate two fine foreign funds that have suffered oversized losses.

Artisan International Small Cap

Yes, Artisan International Small Cap (ARTJX) is closed. Worse, the small/mid-growth fund has fallen 6 percentage points more than the 18.7% average loss in its category and is mired in its group's worst decile for the year to date.

It has been hurt by its geographic exposure, its sector overweights and underweights, and its stock picks. This fund has far more exposure to China and Hong Kong and less exposure to Japan than most of its peers. The first two markets rank among the world's worst this year while the latter has suffered less than most.

The fund also has a much bigger stake in the hard-hit financial sector and a smaller stake in the fairly resilient health care sector than most of its rivals. And a diverse mix of individual names has plunged, including Wirecard, a German electronic-payment and call-center company that is its second-largest holding.

We don't take losses of this magnitude lightly and recognize that it may take some time to overcome them, but we have a lot of faith in manager Mark Yockey and his strategy.

He has earned strong results in all sorts of conditions in the past, including some prior downturns. Despite its recent woes, this fund has still outpaced its typical peers by a substantial margin since opening in late 2001.

And Yockey has produced impressive long returns at much older Artisan International (ARTIX), applying the same discriminating growth strategy he does here to large-cap stocks. Thus, while this closed fund certainly has significant risks -- and will quite likely experience future rough spells -- we remain confident about it.

Quant Foreign Value

A mix of factors has undermined the performance of large-value fund Quant Foreign Value (QFVOX) in 2008. It has one of the lowest average market caps in its group, and small-value stocks have fared a bit worse than large-value issues overseas this year.

It has no exposure to the fairly buoyant health care sector and limited exposure to the relatively resistant energy sector. And a variety of individual holdings have tanked. Anglo Irish Bank and some of its other European financial names have suffered hefty losses, for example, as have its U.K. home-building stocks.

Thus, this fund has dropped nearly 4 percentage points more than its category norm of 15.6% and is stuck in its group's worst decile for the year (as of Aug. 7).

These losses are painful and come on the heels of poor results in 2007, but we continue to believe that the pros outweigh the cons here.

This fund has outpaced its average peer by a moderate margin and the MSCI EAFE Index by a sizable margin since opening in 1998 -- despite the substantial toll its recent slump has taken -- as manager Bernard Horn has delivered superior results in a variety of conditions in the past.

Polaris Global Value (PGVFX), which Horn runs in a similar fashion, has also struggled of late but has a strong long-term record. And Horn's strategy -- which involves going wherever his quant model and fundamental research find the best opportunities -- is sound as well as distinctive.

This fund definitely isn't for timid investors or those who want a mainstream core foreign holding, but we think its future is bright.

This article was reported and written by William Samuel Rocco for Morningstar.