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.

To help distinguish the fund, Clark typically turns to large, dull companies that are off the radar screen of most U.S. investors but have favorable characteristics and a visible presence abroad. Top holdings Xstrata, Akzo Nobel, Fresenius, Sodexo and Saipem, for example, occupy little or no space in most U.S. mutual funds, yet they have solid businesses and prospects for growth. Xstrata, a U.K. mining company, has recently been involved in on-again, off-again acquisition talks with an interested suitor, Brazilian mining giant Companhia Vale do Rio Doce (Vale), in a deal that would create the largest mining company in the world by market value. In April, Vale said it had discontinued the talks to acquire control of Xstrata, but reserved the right to announce a new offer for the firm within the next six months.

Akzo Nobel, a large Dutch industrial company, manufactures decorative paints and is also a worldwide supplier of specialty chemicals. Clark says the company is using its strong cash flow to buy back shares and to make strategic acquisitions. Meanwhile, the management at Saipem, an Italian construction and oil-drilling service company and one of the Henderson fund's better performers this year, has demonstrated an ability to manage business effectively in frontier markets such as developing Europe and the Middle East. And global health-care company Fresenius has successfully penetrated the market for kidney dialysis products and services, an area that should see strong growth with an aging and overweight population. The German company's hospital management arm is also in a position to benefit from plans by its home country to subcontract the management of its hospitals.

The International Opportunities Fund has a propensity for picking stocks that diverge from the standard mutual fund menu. In part, this is because the fund is close to the action in London, but the choices also stem from the decisions of five managers who handle their respective portions of the fund. Stephen Peak is a "growth-at-a-reasonable-price adherent with value leanings" who is responsible for up to 15 of the fund's European holdings. Tim Stevenson looks for up to 10 European growth stocks, while Andrew Millward specializes in Japanese value stocks. Andrew Mattock and Ian Warmerdam choose Asia ex-Japan and global tech stocks, respectively. According to the fund's latest fact sheet, Europe accounts for 56.2% of assets, followed by Japan at 16% Asia ex-Japan at 15% and global technology at 6.2%.

"My role is deciding how much to allocate toward each sleeve of the portfolio so I don't interfere with stock selection. I can argue, debate and voice my opinion, but I can't veto," says the 57-year-old Clark, who came to Henderson Global Investors in 1985 after working as an investment strategist specializing in Japan and Asia for a U.K. investment bank. The firm, which is well known overseas but is something of a dark horse in this country, manages $124 billion in assets and employs more than 900 people.

Among the decisions Clark makes is which sectors and regions to overweight or underweight relative to the index. He is slightly underweight in Europe and very underweight in the U.K., where a high budget deficit and falling interest rates are all too reminiscent of the faltering U.S. economy.
Earlier this year, the fund placed a currency hedge on sterling and the euro in anticipation of those currencies weakening against the dollar. But that did not happen, and the move hurt fund performance against the index. The fund is also underweight in Japan, where Clark sees some attractively valued stocks but nothing to dispel the pessimism that has weighed on that market. The fund is slightly overweight in Asia because of the region's strong growth.

Stock market volatility has created some buying opportunities to fill those portfolio sleeves. The fund's recent purchases include PetroChina, which explores, develops and produces crude oil and natural gas. In Europe, the fund recently sold Puma-because weak consumer demand could cause the stock to track sideways-and put that money into better investments such as Switzerland's ABB Ltd., a power and automation technologies provider that should benefit from infrastructure growth in Asia and in emerging markets.

Clark has also taken advantage of market dips to add to longtime holdings such as Capita Group, a U.K. outsourcing service company that performs administrative work for local governments and private companies. The competition is modest, he says, and the company has grown earnings consistently at a 15% to 20% annual rate over the last eight years.