International stock markets could post decent returns this year, but don't expect the deterioration of the dollar against foreign currencies to provide as much of a tailwind as it has in the past, warns Iain Clark, head of the team that manages the Henderson Global Investors International Opportunities Fund.

"The currency risk that U.S. investors who bought foreign stocks took over the last five or six years has paid off," says Clark, a 35-year veteran of the international markets. "There may be some of that left in Asian markets, but currencies in Europe are more vulnerable."

Henderson Global Investors, the advisor to the fund, views the euro as overvalued relative to the dollar and forecasts that the latter currency may soon begin showing signs of life. The firm believes British pounds sterling could replace the dollar as the weakest major currency as U.K. growth slows, while currencies in Asia will likely continue to strengthen against the dollar.

The direction of currencies mirrors the divergent paths of developed and emerging world economies. In Europe, Japan and the U.S., tightening credit has already slowed economic growth and consumer spending. Henderson forecasts that in 2009 real GDP growth will range from just 1.3% to 1.5% in those parts of the world.

As many developed market economies attempt to ward off or recover from recession, growth remains relatively strong in Asia and other emerging economies; GDP growth of 7.6% is expected in 2009 for Asia outside Japan. "I'm not so sure that if America sneezes the rest of the world catches a cold anymore. Some parts of the world are better positioned to withstand the impact of a U.S. slowdown than others," says Clark.

The downside of that growth is that demand for oil, food and commodities has recently pushed inflation to 8% in China, 5.5% in India and 12.7% in Russia. Clark says emerging countries are trying to keep inflation under control, and that will likely mean their output growth will be weaker over the next few years than it has been over the last four. Global economic growth is likely to slip from an average of 5% in recent years to something more like 3.5% to 4%, the weakest expansion rate in five years.

He warns that stocks could deteriorate if rate cuts fail to support economic growth, although relatively cheap valuations may still attract bargain hunters. "Assuming the outlook for 2009 is brighter, equities [by December] may have got back close to their levels at the start of the year," the firm forecasts.

With countries around the world battling their respective economic demons, Clark says his portfolio has seen few substantive changes in regional or sector allocations in recent months. Such changes in the fund tend to be subtle anyway. Generally, Clark stays within ten percentage points of the MSCI EAFE index country weightings. If the index has a 21% weighting in Japan, for example, the fund can hold as much as 31% and as little as 11% of its assets in stocks of that country.

Clark says that despite that discretionary leeway, he rarely strays more than about five percentage points from the benchmark's country weight. Additionally, he will pare back stock positions when they exceed about 3%, and sector weightings may be no more than double the index's weighting.
Such tweaking, plus stock selection, helps keep the fund from being a pure index hugger. Despite its adherence to its benchmark in some respects, the fund differs from many of its peers in the Morningstar foreign large blend category in the stocks it owns and in the concentration of individual issues. Its focused portfolio generally consists of 50 to 70 "best bet" holdings, while the average peer holds 265. According to Morningstar's database, Nestle, Vodafone and Royal Dutch Shell appear among the top ten stocks in 43.6%, 41.1% and 35.5% of foreign large blend funds, respectively, but have no place in Clark's portfolio. Many other foreign fund favorites are also absent from this portfolio.

Although the fund's performance is reasonably correlated with the index, its off-the-beaten path holdings make it a bit less of an index tracker than many of its peers. "Our correlation with EAFE is about 0.8, but that's still lower than many other managers who are in the 0.9 range," he says. "We try to outperform the index on a consistent basis." In the five years ended March 31, the fund outperformed the MSCI EAFE by an average of three percentage points a year and its Morningstar category average by four percentage points.