Over the past half decade, the exchange-traded fund (ETF) industry has caught the mutual fund industry off-guard. The assets being managed by ETFs have more than doubled in size since 2009, compared with flat growth for their more mature counterparts (though mutual funds still manage more assets overall).
ETFs have proved to be especially popular with investors seeking global exposure. There are now a few hundred country- and region-specific stock and bond ETFs, enabling investors to glean very targeted exposure. For example, as I wrote recently, I think Chile and Vietnam represent sound investment environments.
The appeal of country ETFs is self-evident: They are much cheaper to own than comparable mutual funds, and lower expense ratios can add up to big savings over the short or long haul.
But ETFs also have one major flaw: Their passive portfolios take the good with the bad, as they own a slice of every key company in any given market.
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That makes them solid investments if you prefer global themes such as "the Brazilian middle class is growing," or "South Korean interest rates are set to fall" -- but the approach is not so good at drilling down to the best investment opportunities in a given country.
That's where mutual funds hold a key advantage. Sure, they cost more to own, but the deep research performed by mutual fund managers is more likely to uncover hidden gems or rock-solid values. As a result, mutual funds need to be in consideration if you want your portfolio to have a solid degree of global exposure. (My colleague Tim Begany recently profiled his favorite low-cost top performer among growth funds.)
Here's a look at two well-regarded global mutual funds, each of which carries a 1.5% expense ratio.
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|1. Baron Emerging Markets Fund (Nasdaq: BEXFX)|
This idea comes from Todd Rosenbluth, who oversees ETFs and mutual funds for S&P Capital IQ. He notes that "this fund rose 4.2% in the three-year period ended January 2014, which does not sound that impressive until compared against average emerging-market equity peers, which declined 2.9%." And that performance came with a lower-than-average standard deviation, which suggests less risk for that reward. Rosenbluth also likes that the mutual find comes with no sales load.
This fund's managers tend to focus on consumer cyclical and defensive stocks (which make up 40% of the portfolio), while technology and health care stocks account for another 35%. The portfolio is nicely diversified, with no holding accounting for more than 3%. (In contrast, ETF portfolios, especially the market cap-weighted ones, can sometimes have 10% or even 20% of assets tied up in just one company.)
Steinhoff International (Nasdaq: SNHFY) is a top pick and helps exemplify the kind of stocks that appeal. The South Africa-based company makes everything from furniture to industrial products, and has a sales presence across both emerging and developed economies.
In addition to simply buying this fund, investors can look to better understand their portfolio to see what kinds of companies and industries hold current appeal for top fund managers. Steinhoff has ADRs (American depositary receipts), should investors wish to buy the company's stock directly, though many other of the Baron's fund holdings can only be bought through local exchanges. The mutual fund analysts at Morningstar concur with the bullish view held by S&P's Rosenbluth, awarding the Baron Emerging Markets fund five stars.
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|2. Artisan International Small Cap Investor (Nasdaq: ARJTX)|
This fund gets a four-star rating (out of five) from Morningstar. Fund analyst Greg Carlson notes that the fund managers don't focus on countries or regions but instead on those that are suitable to the current investment climate.
Right now, this fund has a heavy concentration in consumer and industrial stocks. "For example, they've focused on consumer defensive firms benefiting from the rise in many emerging markets of a middle class willing to pay for higher-quality goods," Carlson says. He adds that many portfolio holdings have a growth tilt, rather than value, and fund manager Mark Yockey likes to fund firms that are seen to offer premium goods and premium prices.
It's an interesting angle to think of in the context of the growth of consumer classes in China and elsewhere, which tends to boost consumption of goods that are perceived to be of higher quality. That approach has clearly paid off: This fund has delivered a 21% annualized return over the past five years, compared to a 13% annualized gain for the MSCI EAFE (Europe, Africa, Far East) benchmark.
Risks to Consider: Over the past five years, foreign stocks have continued to deliver a high degree of volatility despite expectations that that turbulence would fade as economies and markets mature. So you should always be prepared to handle sort-term gyrations, and invest abroad with a long-term view.
Action to Take --> Over the past few years, I've concentrated most of my fund research on ETFs, largely because they provide solid thematic exposure with lower expense ratios than mutual funds. Yet it's increasingly clear that it's worthwhile to absorb higher fees when it comes to international investing. The expertise of globally connected fund managers is crucial when navigating local growth and value characteristics -- and these two funds have the track record to prove it.