Offerings from Oberweis, Rainier, and Seafarer are proving even small funds can be competitive when it comes to picking stocks across the globe.
By Rob Wherry | 01-05-14 | 06:00 AM | Email Article

The fund could also stand to improve when it comes to fees. It's 1.6% annual expense ratio is slightly higher than the 1.55% average for the foreign small/mid-growth category. The fund's 280% turnover is also a concern, since such churn can lead to higher trading costs.

Rob Wherry is associate editor of Morningstar Advisor Magazine

Scherschmidt says most of the turnover is the result of taking profits and losses. In addition, Scherschmidt, who has as much as $500,000 of his own money in the fund, tries to manage the trading in a way that minimizes taxes. Indeed, the fund's tax-adjusted returns are some of the best in the category.

Rainier International Discovery: A Smart Call
Earlier last year, Strabo got a little uncomfortable. He had overweighted the fund toward emerging markets. But he grew concerned about slowing economic growth, current account deficits, higher inflation, and rising interest rates in some of those countries. He decided to pull back, cutting the fund's exposure to 16% of assets from as much as 30%.

"It was the biggest change in the portfolio since the inception," he says.

The timing worked in his favor. When the Federal Reserve announced in June that it may begin tapering its stimulus program by the end of 2013, emerging-markets stocks sold off. The fund, which has gained a strong 33% in 2013, was mostly insulated from the drop. Strabo since began adding to blue-chip emerging-markets stocks that he felt were oversold.

When making this call, Strabo relied on past experience. Although the Rainier fund is less than 2 years old, he's been investing in international stocks for more than two decades. Most of his experience stems from his time at American Century, where he was the firm's chief investment officer of international equities and manager of funds such as American Century International Discovery and  American Century International Growth . During his tenure at International Discovery, which ran from 1994 to 2002, the fund gained an annualized 12.5% versus 2% for the MSCI EAFE Index. He guided International Growth to an annualized gain of 8.3% between 1993 and 2005. That tally beat the index by two annualized percentage points.

At his current charge, Strabo looks to build a portfolio of stocks with market capitalizations that are less than $5 billion. Strabo is benchmark aware, staying within reach of the MSCI ACWI ex-U.S. Small Cap Index in most cases, but venturing from that bogy when his team's bottom-up research gives him conviction in a certain stock, sector, or country. He emphasizes quality companies with attractive valuations, strong management, and performance drivers that can propel earnings. He tries to control risk by keeping the portfolio diversified with between 60 and 120 stocks and across regions and by trimming positions as they exceed or fall short of his expectations.

The fund's positive 2013 performance was largely due to top holdings such as Pigeon Corp. and Wirecard. Germany-based Wirecard does payment processing over mobile devices. Strabo likes the firm because it has a strong presence in both developed and emerging markets and continues to develop new client relationships. The stock was up almost 50% in 2013. Pigeon, a South Korean maker of household products, was up about 150% last year.

Another top performer was KakaKu.com, a Japanese price comparison website for shoppers. Strabo has also been dipping into frontier markets, too. A recent purchase was Kolao Holdings, a conglomerate that gives the fund exposure to fast-growing Laos. (The Asian Development Bank estimates the country's economy will grow 7.7% in 2014.)

"We want to invest in companies that are good at what they do," he says. "They have dominant market positions and good products and services. Yet they are small enough to see a clear path to wealth creation."

Strabo is supported by two experienced analysts. But he can also tap the research conducted by Rainier's eight-person domestic team and a small two-person fixed-income team. In total, the firm runs almost $11 billion.

Seafarer Overseas Growth & Income: Starting From Scratch
Foster knows what it's like to have a plenty of resources at his disposal. As a portfolio manager at Matthews Asia funds in the 2000s, he could lean on about a dozen portfolio managers and analysts. Now, though, he has just two associate portfolio managers to split the research duties with. And that's the way he likes it. To Foster, having an army of analysts on the ground in local markets is overrated.

"Boots on the ground sounds wonderful," he says. "But if you are in the local market every day you can fool yourself into thinking you know more than you actually do."

Foster's goal is to use a combination of stocks, preferreds, and convertible bonds in order to build a portfolio that can generate capital appreciation and current income. He largely avoids making top-down decisions based on macroeconomic trends. Instead, he favors picking emerging-markets stocks with attractive valuations and consistent cash flows that can be used to pay dividends. He keeps the fund diversified across sectors and regions. But holding just 41 positions, the fund is a bit concentrated. Indeed, 35% of assets are in its top 10 holdings.

Lately, Foster has been focusing some of his research efforts on the traditional BRIC countries--Brazil, Russia, India, and China-- but especially Brazil. These countries were under-represented when Foster launched the fund because he had valuation and currency concerns. Now, slowing growth in China has spilled over into Brazil, a chief trading partner. Foster says the dips in the BRICs have presented an opening. He is leaning more toward service-oriented firms. He recently initiated a position in Valid, a Brazilian company that manufactures credit cards and cellular phone cards and prints driver's licenses and corporate photo IDs. Another holding is Odontoprev, which specializes in dental benefits.

"The hot market is actually going to be the market within the hot market," he says. "The real frontier is the services sectors in these countries. It's reminiscent of the U.S. in the 1940s. And those domestic sectors are undervalued in a lot of countries."

There is ample reason to buy into what Foster is saying. As a key manager on the teams running  Matthews Asia Dividend ,  Matthews Asian Growth & Income , and  Matthews India , he helped post performance throughout the 2000s that easily outpaced the MSCI EAFE Index.

In the early going at Seafarer, Foster has been able to add value compared with peers in most sectors.  NTT DoCoMo and Malaysia glovemaker Hartalega were two of the fund's top performers the last year. Gains from those stocks, though, were somewhat washed out by Latin America holdings such as Chile-based SQM, which produces specialty chemicals. Its shares fell on weak exports. That stock is no longer in the portfolio. Foster, though, has largely been sticking by his positions, as evidence by the fund's 39% turnover (versus 72% for the category average). And he thinks the consumer-oriented names in the portfolio will pan out over the long haul.

He adds a word of caution for emerging-markets investors: "You have to analyze the control party," he says. "In most cases, the company has a person or entity behind the scenes that sets the agenda. It is essential to know their intentions."

This article originally appeared in the December/January 2014 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.

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