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Vanguard MSCI Emerging Markets ETF (VWO), iShares MSCI EAFE Index Fund (ETF) (EFA): The New Hot Spot for Foreign Stocks

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Foreign investors haven’t had the easiest time as of late. Stocks in developed markets have posted a negative 1.3% annualized loss over the past five years, while the S&P 500 is up 4.8% in the same time period. Emerging markets have had troubles of their own — since May of 2011, stocks in developing nations have lost a cumulative 16.2%. But, despite the sector’s recent struggles, investors have benefited from owning foreign stocks over longer time periods, and should continue to reap those rewards as global growth gets back on track. So what’s the best way to get your international exposure nowadays?

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Staying active

Foreign exchange-traded funds have been racking up assets as fast as actively managed funds have been losing them in recent years. In fact, the two largest foreign stock ETFs, Vanguard MSCI Emerging Markets ETF (NYSEMKT:VWO) and iShares MSCI EAFE Index Fund (ETF) (NYSEMKT:EFA), now hold more than $50 billion and $42 billion in assets, respectively. It’s hard to deny the obvious appeal that ETFs hold — they offer inexpensive, broad coverage in one easy package. But, when it comes to international investing, actively managed funds may actually hold the upper hand.

New research by professor Abhay Kaushik of Radford University shows that in the foreign arena, active funds do a better job of beating their benchmarks than do actively managed domestic stock funds. Kaushik’s research, entitled “Performance and Persistence of Performance of Actively Managed U.S. Funds That Invest in International Equity,” was recently published in the Journal of Investing. This study concluded that, from 1992-2011, the average active foreign equity fund in nine out of 13 fund categories beat its benchmark based on both total returns, and risk-adjusted returns. The author concluded that “the superior risk-adjusted returns of international equity funds support the superior selectivity skills and value-added features of active management.”

While this study certainly isn’t conclusive, it does lend evidence to the idea that active management may be more advantageous for overseas investing than for investing closer to home. Fortunately for foreign investors, there are a number of excellent actively managed international funds that are relatively affordable, feature time-tested managers, and have proven track records of beating their benchmarks.

Against the grain

Oakmark International I (OAKIX) employs a contrarian approach to foreign investing, which means it’s not afraid to delve into unloved sectors or countries. For example, the fund has long been overweight in Japanese stocks, even as many managers have written the country off as a lost cause. Likewise, the fund is also heavily weighted in the much-maligned financial sector. Swiss financial services firm Credit Suisse Group AG and the U.K.’s Lloyds Banking Group PLC land in the fund’s top five holdings on the strength of their market dominance, and the low price at which management was able to acquire them in the wake of the recent global crisis.

Managers David Herro and Robert Taylor don’t limit themselves to stocks that fall in the traditional value camp, but are willing to pick up any name that exhibits a wide discrepancy between stock price and its fundamental value. Over time, this strategy has led to impressive market- and peer-beating performance. During the past decade, Oakmark International has racked up an 11.4% annualized gain versus a 7.9% return for the MSCI EAFE Index. In that time frame, the fund also ranks in the top 1% of all large-blend foreign equity funds, making it a fine choice for nearly any investor.

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