International core equity funds offer good options for both passive and active fund investors: Funds focused on developed Europe offer attractive relative value with U.S.-type growth opportunities, while Asia Pacific–focused funds potentially benefit from recent volatility.
Emerging markets funds demand greater selectivity, and emerging markets debt funds are in for another volatile year. Commodity funds, meanwhile, remain lackluster despite gold achieving some price stability.
U.S.-based investors invested heavily in world equity markets during 2013, with $160 billion of net inflows going into U.S.-registered world equity funds (including exchange-traded funds). As of Feb. 12, this positive net-flows trend—with $15.5 billion going into the segment—had continued despite recent global market volatility.
As world equities remain poised to continue to gather assets, the international core equity segment remains a solid area for portfolio allocations in 2014, as many of the world's equity markets—particularly Asia and, to a lesser extent, Europe—have lagged the U.S. in recent months and now appear to be better positioned to narrow that gap. Asia stands to gain from improved exports as a result of the stronger dollar, while Europe looks to benefit from banking-system stability and slow but steady growth.
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In the international multicap core equity space, passive products, such as Vanguard Total International Stock Market Index, should continue to gather assets in 2014 as investors seek to diversify their portfolios in these proven low-cost investment products. Many investors have become too overweighted to U.S. equities following their strong 2013 performance and should consider taking advantage of the opportunity to rebalance at reasonable valuations to a passively managed fund that has the greater exposure to both Asia and Europe.
Additionally, some actively managed funds in the category, such as Oakmark International Fund and MFS International Value Fund, have posted both strong absolute and relative returns and continue to attract new assets. As well, they now offer active investors a greater array of potential alpha opportunities than they may currently have domestically. Active funds that are well positioned generally have significant exposures to large capitalization names in Europe and, to a lesser extent, in Japan that should do well in a slow-growth global expansion.
Where have investors been putting their money in international equities?
European region equity funds are looking more attractive on a relative basis to domestic equities as the economic outlook slowly brightens for the euro zone economies. Germany's GDP growth has gradually risen, while the euro banking system has stabilized and remains on the mend.
Stronger than anticipated demand from U.S. and Japanese manufacturers continues to help drive export demand. These factors—combined with rising cross-border demand within euro zone countries, improved labor flexibility in southern Europe and a steadily expanding U.K. economy—bode well for the European markets.
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Small cap–oriented funds are positioned to outperform here, as many of their holdings will benefit from pent-up internal euro zone demand. Popular ETFs with exposure to Europe include the iShares MSCI EMU ETF (EZU), which had $5.1 billion in net flows in 2013, and the small cap–oriented WisdomTree Europe Small Cap Dividend Fund (DFE), which witnessed $501 million in positive flows last year. As of Feb. 18, EZU has returned 1.31 percent year-to-date, while DFE has risen 6.71 percent.
One of the top categories for 2013 ($25.5 billion), excluding ETFs, in terms of net inflows in the world equity segment was emerging markets funds. This should not be the case in 2014.
Emerging markets fund inflows have benefited greatly from a global search for yield and investors' willingness to assume a higher risk profile. However, because of recent emerging markets volatility—arising from Federal Reserve tapering, less business-friendly political environments in Latin America and depressed commodity prices—this will be an area to consider largely avoiding going forward in 2014.
However, emerging funds focused on the Asia-Pacific region, such as SPDR S&P Emerging Asia Pacific ETF (GMF), stand to benefit from higher local interest rates that are attracting capital to areas such as Indonesia and India, where currencies have stabilized following market-led devaluations. Improved export growth in China also bodes well for the region.
Emerging markets debt
Emerging markets debt funds are in for another volatile year, as both global interest rates trends and political climates temper expectations. Year to date, the Lipper Emerging Market Hard Currency Debt Funds classification has experienced $1.0 billion of net outflows; for 2013 the segment lost $5.9 billion.
This trend across emerging markets debt funds is poised to continue in upcoming months as investors reassess the global interest-rate environment. Fund investors may want to avoid the asset class entirely in the upcoming months as political developments play out in Eastern Europe and Latin America and global interest rates seek a new equilibrium. Fund investors should keep in mind that periods of emerging markets debt disruption have historically taken longer to pass than anticipated.
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Where have investors been putting their money in international/global debt?
The major source of volatility and fund outflows in the commodity sector has been within the commodities precious metals segment. The year 2013 witnessed strong net outflows at $28.4 billion from the funds segment (including ETFs). The SPDR Gold (GLD) ETF witnessed $24.9 billion in net outflows during 2013. With the price of gold fluctuating around $1,250 per ounce in February, after trading more than $1,600 per ounce a year prior, net flows to the segment are likely to remain flattish in the short term.
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As global markets achieve a greater level of stability, investors may still want to avoid this asset class and its volatile performance, deploying commodity allocations instead to the domestic energy sector, as refined energy prices remain high on infrastructure bottlenecks despite expanding supplies.
Where have investors been putting their money in global equity ETFs?
—By Barry Fennell, Special to CNBC.com. Barry Fennell is a senior research analyst at Lipper, specializing in mutual fund research and performance analysis.