International Funds Rock On

But the lockstep decline is something of a blip in what has mostly been a period of international dominance, when both managers and investors have warmed to foreign markets. Over the last three years, the average international equity fund is up 21.54% annualized, more than double the returns of the average domestic equity fund (10.74%), according to investment-research firm Lipper. (The average global equity fund, which invests in a mixture of international and domestic stocks, is up 16.09%.)

"I definitely think there's more comfort investing overseas," says Jeff Tjornehoj, Lipper senior research analyst, who recommends a 15% to 30% equity allocation in international funds.

Given recent fund flows, it wouldn't be surprising if many investors were pushing the high end of that range. Through June, international and global funds had registered $106 billion in net flows for 2006, dwarfing the $22 billion into domestic equity, according to Financial Research Corp. (FRC).

A whopping $6 billion has flowed into the Dodge & Cox International Stock (DODFX) fund — one of our picks for today's screen — in 2006. That's the fourth-largest gain among all funds, according to FRC. Like most international funds, this fund, which is up 30.55% annualized over the last three years, has benefited from weakness in the U.S. dollar and strong economies abroad.

The fund uses a variety of metrics to build a broad portfolio of "temporarily undervalued" foreign stocks with growth potential. Turnover is an exceptionally low 7%, which should assuage the fears of investors who still think foreign markets are for gamblers only. That said, the fund is not immune to dips. Like most of its peers, the fund lost ground in the spring and early summer, losing about 5% from May through July. And about 15% of assets are invested in emerging-markets equities, about three times the average international fund's stake in that ever-volatile segment of the market.

Of course, the top performer on our list this week, Janus Overseas (JAOSX), has about 15% invested in Brazil alone. And that's on top of large stakes in India, South Korea and China. Despite second-quarter losses, manager Brent Lynn says he's not pulling back. The 15-year Janus veteran trumpeted the promise of Chinese and Brazilian real-estate companies, among other emerging-market plays, in a July letter to shareholders. Lynn may turn out to be right. Emerging-market funds are no longer bleeding like they were in late May and early June. But his brand of international investment isn't for everyone.

Fortunately, not all of the funds on our screen this week got there by betting heavily on developing countries. ICAP International (ICEUX) and Fidelity International Discovery (FIGRX), for example, invest mostly in Western Europe and Japan.

Looking ahead, there are signs that international funds, which were about three percentage points ahead of their domestic counterparts in July, will continue to outperform broadly into 2007. The dollar continues to show weakness abroad and European economies reported strong growth in the second quarter.

Eventually, however, the dollar will strengthen and American investors may lose their affection for overseas investments. But, when that happens, they would be wise to remember these good years, and keep their portfolio properly diversified for the next turn.

The Criteria
This week, we turned our fund screener to the broad universe of international funds, looking for low-fee top performers. We required three- and five-year returns in the top 25% of each fund's respective classification and expense ratios in the bottom 25%. Each fund that made our list is no-load, open to new investors, and accepts minimum initial investments of $5,000 or less. Finally, these funds all have at least $50 million in total net assets. Twelve funds made the cut.