Most results won't surprise, but others may raise some eyebrows.
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By Gregg Wolper | 07-05-11 | 06:00 AM | Email Article

When Morningstar created a new category last autumn to house the plethora of China-related funds that had appeared on the investment scene, we cautioned that we were not making a market call in favor of China or encouraging people to buy the funds. The change simply had become necessary from an administrative standpoint. The sheer number of China funds was overwhelming the Pacific/Asia ex-Japan category.

Gregg Wolper, Ph.D., is a senior analyst covering active strategies on Morningstar’s manager research team.

In hindsight, it seems we should have gone further and issued a warning: "Alert! When the fund industry pumps out so many funds of a given type that we need a new category to contain them, they might be ready to slow down."

Eastern Worries
The first half of 2011 is now in the books, and the China-region category did not fare well. It had the worst performance of Morningstar's 14 international-stock groups, with a loss of 3.1%. In second-to-last place was Japan-stock, which suffered a 2.6% decline.

It's no mystery why both categories struggled. In China, fears of slowing growth and rising inflation made investors cautious, and recent accusations of faulty accounting at a number of smaller companies have further dented confidence. In Japan, the earthquake, tsunami, and ongoing nuclear crisis have created misfortune and uncertainty for millions in that country, and the economy and stock market were strongly affected as well. The market quickly recovered some of the deep losses it suffered in the first two days after the earthquake, but not all of them, as Japanese companies warned that they were having a variety of troubles related to the crises.

Meanwhile, China wasn't the only problem for funds in the often-hot diversified emerging-markets category. India's stock market, also afflicted by worries about rising interest rates and inflation, suffered an even-greater decline than China's did, and Brazil was sluggish as well. Largely as a result, the category landed 0.4% in the red.

By contrast, funds investing in a region attracting plenty of negative attention posted surprisingly good results in the first half. The best performer of all the international-stock categories was Europe-stock, in spite of the Greek debt crisis, concerns about debt woes and austerity legislation in several other countries, and unimpressive growth rates in many areas of the continent. The category gained 6.3% in the first half.

Size and Style Effects
For much of the past decade, small and midsize companies have outpaced the giants in foreign stock markets. Not so in this year's first half. Therefore, this factor did not have a significant impact on the performance of individual funds. The same goes for style considerations. In many periods, value outperforms growth by a wide margin, or vice versa. But in the past six months, that effect was muted. The value side came out ahead in the large-cap and small/mid-cap categories, but not by much.  

In fact, a look at the table of category results shows the groups tightly bunched. Except for foreign large-value--the best performer of the broad foreign style-box groups with a 5.2% gain--the other foreign style-box categories all landed in a range between 3.4% and 4.2%.

A Look at Individual Funds
One fund that has benefited, relatively speaking, by the fact that emerging markets lagged is  Causeway International Value . This fund, which stays out of emerging markets as a rule, gained 7.6% in the first half, good enough for the 10th percentile in the foreign large-value group. The lack of emerging-markets exposure wasn't the only thing helping this fund. Most notably, number-two holding  British American Tobacco  scored a double-digit gain in the first half.

Health-care workers won't want to hear this, but tobacco has generally been a rewarding place for funds to be this year. Note the showing of  Virtus Foreign Opportunities . A large India stake could have derailed this fund. Instead, it landed in the 5th percentile of the foreign large-growth category, with a 7.4% gain. Manager Rajiv Jain has long favored tobacco stocks, not only as defensive plays but also for their growth potential in emerging markets. The portfolio has British American and three other tobacco stocks in its top 15 holdings, and all provided solid gains. In fact, a key reason the India overweight didn't sink the fund was that one of those stocks was a tobacco firm.

On the Down Side
One might think that India stocks do account for the disappointing first-half results of  Janus Overseas , but that's not the whole story, or even most of it. This fund has had a large overweight in India for a long time under manager Brent Lynn, and to be sure, Reliance Industries, a top-five holding in the March 2011 portfolio, was deep in the red in 2011's first six months. But other top holdings located far from India suffered as much or more. Those include Li & Fung and  Bank of America . In fact, the only other India stock in the top 25 was well into positive territory in the first half. With a 7.1% loss, this fund landed near the bottom of the foreign large-growth category.

Another fund that would like to forget 2011's first half is  Bernstein Tax-Managed International . Unlike Janus Overseas, which had a stellar long-term record entering this year, the Bernstein fund's lackluster showing in 2011 continues a long string of underperformance. In this year's first half, the fund was in the foreign large-blend group's bottom decile, more than 3 percentage points behind the category average. This fund has relatively small stakes in individual stocks and doesn't have notable sector or country over- or underweights. So, it's not as clear-cut what the issues were. But with its negligible emerging-markets exposure in a period when those markets lagged, shareholders could have expected better here. 

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Gregg Wolper does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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