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Weekend Investor

International stock funds in a world of hurt

Reuters

SAN FRANCISCO (MarketWatch) -- "Stop the world, I want to get off" must be a common refrain these days for international-stock-fund shareholders.

A tumultuous second quarter leaves in its wake bailed-out countries and burned-out investors. European leaders' agreement to bolster failing euro-zone banks ignited a global rally on Friday for stocks, gold and oil, but it remains to be seen whether this latest show of risk-taking will gain a following.

"On the one hand, you have a grand experiment, the euro, that was doomed to fail," said Matthew Tuttle, chief investment officer at Tuttle Wealth Management LLC in Stamford, Conn. "On the other hand, you have a bunch of people who have so much at stake that it doesn't. Whatever happens will have a massive impact on the market."

So it's no surprise to see that international-stock-fund categories posted overall declines in the second quarter on average, with Latin America down more than 13%, India falling 8.4% and Europe losing 8.2%, according to preliminary data from investment researcher Morningstar Inc.

International exchange-traded funds were also mostly lower for the quarter, with Europe and Latin America issues hit hardest, Morningstar reports.

"Markets hate uncertainty," said financial adviser Harvey Rowen, head of Starmont Asset Management. "In the face of uncertainty, investors sell what they perceive to be riskier assets and buy what they consider to be less risky assets. They will sell from more uncertain parts of the world first, and then from less uncertain parts of the world."

"The acceleration of the European debt crisis has begun to have a contagion effect on emerging markets," added Jeff Sica, president and chief investment officer of Sica Wealth Management.

"Several of the historically strong emerging-markets [and] international funds have begun to see the growing European debt crisis affecting their net asset values," he said. Plus, "the dramatic economic slowdown in India and China has begun to negatively affect international and emerging-markets funds."

International bourses have suffered, too. As of Friday's close Spain's IBEX 35 Index (IBEX) was among the quarter's biggest decliners, down 11%, while the broad-based Stoxx Europe 600 (SXXP) lost 4.6%.

Among emerging markets, India's Sensex (1) turned higher for the quarter, up 0.2% following Friday's rally. Meanwhile, Brazil's Ibovespa (BVSP) had lost 16% in the quarter and, Egypt's EGX 30 Index (EGX30) was down about 6%.

U.S. stock-fund investors were not spared, either. The average U.S. diversified stock fund shed 4.9% in the 13 weeks through June, while its index-tracking ETF counterpart lost 3.7%, according to Morningstar.

Bond funds, meanwhile, continued to safeguard investment portfolios. Read more: Bond funds could be on borrowed time.

Emerging markets submerged

After such hefty declines, investors can't help but question whether now is a good time to take another look at international assets. Indeed, world stock funds, which invest both internationally and in the U.S., continued to take in new money during the second quarter -- an estimated $5 billion cascaded into these vehicles in the period through June 20, according to the Investment Company Institute, a fund-industry trade group. Meanwhile, cash cascaded out of their purely domestic U.S. counterparts. Read more: It's 'duck' season for U.S.-stock-fund investors.

There were a few bright spots in the global markets, specifically the Philippines and Turkey, while Latin America and India took the biggest hits.

Falling the least among international mutual funds in the second quarter were the China region, diversified Pacific/Asia and foreign small/midcap growth categories, each losing around 6% in the period. One standout in the group was Matthews Asian Growth & Income Fund (MACSX) , down just 0.8%.

The Philippines, China real estate and Turkey were among the better performers in ETFs. The iShares MSCI Philippines Investable Market Index (EPHE) , for example, added almost 5% in the quarter.

"All markets have their unique twists," said Bill Kornitzer, a portfolio manager of the Buffalo International Fund (BUFIX) , which lost about 6% in the second quarter.

"Turkey is viewed as having the right leadership and found a balance for a modern, open, heavily Muslim economy," he said. Meanwhile, "the Philippines has been an increasing destination for lower-wage manufacturing and service industries with a heavily English-speaking population, which has continued to favor economic growth."

But the Philippines' small size also makes it "vulnerable" to China's slowdown, said Wojtek Zarzycki, chief investment officer at Optimal Investing.

He also said he would stay "very far away" from Chinese real estate. "The surprise rate cut by the Chinese central bank is not a pre-emptive move, and the amount of bad debt continues to grow at Chinese banks."

The worst-performing international mutual funds include ProFund UltraLatin America (UBPIX) and Direxion Monthly Latin America Bull 2X Fund (DXZLX) , leveraged vehicles that each lost around 24% for the quarter, according to Morningstar. J.P. Morgan India (JIDCX) stands among the worst performers in the India equity category, down about 7%.

Latin America is "highly exposed to the export of raw materials, which has been crimped due to lower commodity prices in general and a slowdown of China consumption growth," Kornitzer said. Read more: Money managers believe emerging markets will outperform.

Lackluster demand weighed on commodities and precious metals. Friday's market rally spurred hopes for a pickup in demand, boosting oil prices more than 9% and gold 3.3% on the day. Still, for the quarter, oil futures (CLQ2) were down 18%, while gold futures (GCQ2) shed 4%.

India, meanwhile, "has generally failed to keep up the progress of other BRICs despite relatively high overall GDP growth, mostly due to a stumbling bureaucratic and insular approach to development," Kornitzer said, referencing so-called BRIC countries Brazil, Russia, India and China.

And opportunities in India won't likely look up until the government takes significant action to "right the ship," Zarzycki said, adding that since such a move isn't likely in the short term, India "would not be a recommended destination to invest at this time.

"The notion that the BRICs are a mainstay of global growth has recently been tested," said Paul Herber, portfolio manager of Forward Frontier Strategy Fund (FRONX) , which is down about 8% over the past three months. "Across the board, these countries are showing signs of stress."

Growth in Brazil has been declining, and China has reduced its long-term-growth forecast, he noted. India's politicians are "completely dysfunctional," he said, and "the country is really straining under the burden of uncontrolled bureaucracy."

A look ahead

At the same time, developments in Europe have continued to rivet investors. Dim prospects for a definitive solution to the region's debt issues fuels pessimism about international-stock funds and drives investors to safer assets.

"The solution du jour to the Europe problems seems to be kick the can down the road instead of rip the Band-Aid off -- feel the pain now and then get better," said Tuttle of Tuttle Wealth Management. "This leads to a lot of news-based volatility and some large downturns."

Stateside investors should "avoid anything international" until the situation overseas stabilizes, he said. "If you are nimble, there will be some good countertrend opportunities to buy some big dips, but, for the typical investor, they are better off elsewhere."

Once international markets find their footing, according to managers, investors will be able to capitalize on an eventual recovery.

"International funds that are focused on energy and industrials will outperform over the longer term," said Robert Fuest, chief operating officer and head of investment research at Landor & Fuest Capital Managers LLC. "Funds focused on the needs of nations will continue to have companies they hold that outperform, such as food, water, infrastructure."

For now, however, global recovery hopes are pinned tightly to Europe.

Said Brad Sorensen, director of market and sector analysis at the Schwab Center for Financial Research: "It's hard to construct a scenario where investors get confident in equities and start to put money into the stock market until Europe decides what they're going to do.

"The market is not really interested in half-measures."