Looking Abroad for Hidden Gems

Given the spectacular results of small foreign companies over the past few years, instinct may tell you that now isn't the best time to invest in this group. But there is a case for reserving a slice of your portfolio for a diversified mix of these kinds of stocks. Even more so than stateside companies, tiny firms abroad receive scant analyst coverage -- which means there are plenty of undiscovered gems to be mined.

Swollen with a flood of new money, many of the best international small-company funds have closed to new business. One that hasn't is Forward International Small Companies, and it's a fund well worth considering. Over the past five years to November 1, its institutional share class returned 23% annualized, beating the typical foreign small-company fund by an average of two percentage points per year. Yet assets, at about $500 million for all classes combined, remain relatively modest (there's another $1 billion in separate accounts).

Forward is one of the more conservative funds in its category. Run by Switzerland's Pictet Asset Management, the fund focuses on developed markets. Western European and Japanese stocks account for about 85% of the portfolio, with the rest mainly in other Asian companies.

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Pictet uses computers to identify companies with market values of less than $3 billion and accelerating profit growth that other investors haven't yet come to appreciate. Then the six managers, who are split between offices in London and Geneva, study the companies to understand their strengths and weaknesses and the ability of their executives. Each manager covers a region where he or she has extensive experience. "In getting to know these companies, it's important to speak the language and know the local culture," says lead manager Aylin Suntay.

From the roughly 250 companies that the computer typically spits out, the managers select about 100 stocks. Holdings fall into such categories as emerging-growth companies that are churning out annual earnings gains of 20% to 40%, more-established companies that normally generate earnings improvements of 15% or so a year, and cyclical growth companies that are expanding because of strength in the economy. The fund is well diversified, with no stock accounting for more than 1.2% of assets.

Forward's four-year-old investor class (symbol PISRX; 800-999-6809) requires $4,000 to start and charges 1.56% annually. That's not cheap, but it compares favorably with the average expense ratio of 1.73% for all small-company overseas funds.

Forward favorites

Valentino Fashion Group, based in Italy, is a play on the increased demand for luxury products in Eastern Europe and Asia. Major labels include Valentino and Hugo Boss.

Europeans also like shopping at the low end, which explains the fund's holdings in Germany's Bijou Brigitte, a company that sells inexpensive accessories in stores throughout Western Europe.

Forward owns several real estate investment trusts, including Singapore's UOL Group, which invests in commercial property throughout Asia. It is the only one of these three firms that trades in the U.S.