International markets outperformed their U.S. counterparts for the sixth straight year last year, although that performance has been tempered and is expected to slow in 2008.

The sector's attractive relative valuations still support a healthy outlook for international investing, says Bob Smith, the manager of T. Rowe Price's International Stock Fund. Smith is warning, however, against investments in global companies that will be roiled by a U.S. slowdown and fluctuations in the dollar.

"Asia still shows strong growth potential, Europe is in better shape than it has been in the past and emerging market fundamentals remain robust," says Smith. "Looking ahead, international equities should continue to outperform the U.S., and emerging markets should outperform developed markets, albeit at more moderate levels than in recent years."

Of course, fund performance is relative, especially these days when there is little in the investment world that hasn't fallen from grace.

The S&P 500 index was down more than 9% year to date in March, while international blend funds were down 6.19%. The T. Rowe Price International Stock Fund that Smith manages was down some 8.4%. If you take away the currency advantages, European markets didn't perform much better than the U.S., says Smith, who is concentrating on growth stocks and shedding concentrations in names such as AXA and Toyota.

T. Rowe Price managers' main concern is the impact that a U.S. slowdown would have on companies that depend on U.S. companies to buy their goods and services. The United States still accounts for 25% of global GDP and is the primary buyer for many international firms. So if the U.S. slows down, the rest of the world will slow down too, something that is  starting to materialize.

Still, there are undeniable positives in Europe, which is reaping the rewards of steady economic growth, rising employment and strong demand from emerging economies. Inflation is under control and consumer spending remains steady. Japan and Asia aren't faring as well, since spending is down and economic growth is slowing in those regions, resulting in performance that has severely lagged that of other developed countries for two years running.
While T. Rowe Price's Smith tends to steer clear of smaller and mid-cap stocks, another fund manager, Cynthia A. Tusan, believes her fund-the Aston/SGA International Small-Mid Cap Fund-is perfectly positioned to exploit those international market capitalizations. You can't buy a benchmark for this fund, launched last November, which Tusan says is an exciting prospect. "It's hard in this business to offer value-added, and we believe we're doing that."

The fund uses a multifactor quantitative model to look for up to 150 of the most attractive international stocks based on valuation, growth, quality and sentiment. Tusan says her fund uses bottom-up stock selection to identify companies with the potential for high, risk-adjusted returns. Aston's year-to-date return is -7.61%.

"Because what we do is so challenging, there is very little competition in this space, and it lends itself to quantitative analysis," Tusan says. "We believe that the decline is behind us and our investors coming in the door now won't have to suffer that."

One of the international sector stories Tusan's fund likes is shipping and transportation in Asia. Names Tusan is buying include Neptune Orient Lines and Orient Overseas. Both are marine transport companies, based in Singapore and Hong Kong respectively, with vast exposure to Asia's growth in trade and commerce. Tusan also likes Air New Zealand, which she says is a central player in Asian travel, which is on the rise.

Tusan also likes European banks. "What people will be surprised to know is there is no subprime lending crisis in Europe, so it's a haven of sorts for the problems U.S. lenders are experiencing right now. I think the whole European financial services arena is a great place to be."
Obviously, with a small- and mid-cap orientation, Aston/SGA International is always on the lookout for emerging market companies, but reserves the right to invest in developed markets as well, with market caps between $100 million and $15 billion."What we're trying to deliver here is a core international portfolio. We're trying to deliver alpha," Tusan says.

On the opposite end of the spectrum, Kirk Brown, the portfolio manager for American Beacon International Equity Fund, is on the lookout for value stocks, and largely avoids some of the risks associated with international small-cap and emerging market funds.
The fund uses a multimanager approach and "is a worthy choice for investors seeking relatively tame foreign exposure," says Morningstar analyst William Samuel Rocco. The fund has three-year returns of 10.8% and five-year returns of 20.43%.

"We are looking for stocks with attractive future values, and a catalyst that will unlock those values, regardless of what the sectors or countries turn out to be," says Brown. "Our managers do well investing in more defensive names, not tied as much to the economy. We're looking for stocks that will do well in a slower environment."

American Beacon's top picks these days? One is Sanofi-Aventis, the French drug company. Brown says Sanofi, the No. 1 drug company in Europe (and No. 3 worldwide) wasn't generating the kind of earnings analysts expected, so it fell off the radar a number of years ago, but now it's gaining momentum with a stock repurchase program and a planned increase in its dividends.

Right now, the American Beacon fund has an underweighting in financials and materials and an overweighting in telecom, but the managers aren't writing off the first two sectors. "We are re-evaluating financials and materials now. At some point, there is going to be a time when the stocks hit their price targets," says Brown. "We're doing a lot of work analyzing these stocks, and we're seeing the cleanup of books and loan write-offs. These may be attractive sectors going forward."

On the telecom front, Brown likes Vodafone. "There is increased phone usage throughout Europe. Part of the catalyst for us is the company has a low double-digit P/E ratio and no major capital expenditure projects in the works."

Vodafone, like many telecoms, spent hugely on licensing throughout Europe, but since 2000, the company has pared back, written off debt and gotten back to basics, Brown says. "The price came down hard in 2000 and languished there. It was no longer a sexy story or momentum-type company, so it lost its following. It's in our top five stocks because we really believe there is great upside and the downside is limited," Brown says.
Investors looking for a different type of international fund may find it in the Utopia Yield Income Fund, which has a year-to-date return of 0.58% and a "do-no-harm" philosophy of investing.

The fund looks for both solid bond and equity offerings around the globe. "A lot of people think that global is something that you add to a portfolio," says Paul H. Sutherland, portfolio manager of the Utopia fund. "We believe that all money should be managed globally. Anything else is silliness. Everything is global, so that's our main operating principle: The world is our oyster."

Fittingly, the fund's tagline is "Investing Without Borders," and it does just that, with investments spread throughout the world, including the United States, where it has been favoring bonds lately. "Dividends helped us a lot with performance," Sutherland says. But that doesn't mean the fund's manager isn't scouring the globe for opportunities. Right now, Sutherland says, he likes energy companies, particularly Pargesa in Switzerland, which has the advantage of the Swiss franc backing it and is trading at a 30% discount. "Its holdings are impressive. It owns a big chunk of Total, the oil and energy conglomerate, as well as energy companies Imerys and Suez, and also has significant assets in wind energy."

That impresses Sutherland. Another company he likes is Australia's Babcock & Brown Wind Partners, which has wind farms all over the world. "We think this is an incredible opportunity, with more than half the states in the U.S. offering subsidies and credits for the use of wind energy," Sutherland says. With oil hitting the $100 mark per barrel, wind is becoming more competitive. Another reason to like the company: It's paying shareholders a 9.89% dividend.

The Utopia fund does a lot of tire kicking-literally. One of Sutherland's analysts even went to a dealership and test-drove the pricey and sought-after Italian motorcycle by Ducati before the fund started buying the company's stock. "We do research at the consumer level and think great products make great companies," the fund manager says.

Another company that has caught Sutherland's eye is India Hospitality, which builds hotels throughout India. The country has 1 billion people, is increasingly a mecca of tourism and has very few affordable hotel rooms. "It's a huge open market, and we like it," Sutherland says.

"We're a go-anywhere, value-oriented fund with no limits on market caps, and we're starting to see a lot of bargains out there," he concludes.