According to Morningstar, over the past year, the average mutual fund return in the European stock category has been negative and hovering around 17.70%. The category was much stronger over the last three years and has returned close to 7.99% annually. However, over the past five years, which includes the credit crisis, the return dips back into the negative territory with an average annual loss of more than 7%.
As the above data shows, navigating Europe has been quite frustrating for investors over the past several years. On average, mutual funds that invest in Europe, or regions that are close to Europe, posted negative returns with only a small window in the positive territory in between the credit debacle, the current round of sovereign debt worries and national banking woes.
Overall, actively-managed funds have a dismal track record of outperforming underlying indexes. The small-cap international space was recently pegged as a category where active managers have demonstrated at least some skill in beating their bogeys, but for the most part managers don't add any value for investors.
Excessive fees were also to blame. In the European fund category, most funds tracked by Morningstar charged annual expense ratios that were well above 1%. Many charged fees that were close to 1.5% while a few, including in the small-cap European category, charged rates above 2%.
Exchange traded funds (ETFs) that track underlying European indexes appeared to charge much more reasonable expenses. The Vanguard MSCI Europe ETF, which tracks the European index created by investment data firm MSCI, charges only 0.14%, which it states is lower than 91% of similar funds out there. The iShares EMU Index Fund, which is designed to track countries in the European Monetary Union, charges an expense ratio of 0.52%. The iShares S&P Europe 350 Index Fund, which tracks an index created by Standard & Poor's, charges 0.60%. The iShares ETFs may appear high for ETFs in general, but is still much lower than actively-managed alternatives.
Each ETF has performed in near tandem with its mutual fund counterpart: The Vanguard MSCI Europe ETF has had a three-year market return of 6.46%, and a -6.58% return for the past five years. The iShares S&P Europe 350 Index Fund saw similar returns in the three- and five-year range at 5.74 and -7.07%, respectively. Though not exactly stellar in terms of performance, the lower fee attached to these funds equals larger returns for the investor than mutual funds.
For some reason, mutual funds that passively track European indexes are hard to come by. Vanguard does offer a European Stock Index Fund that charges only 0.26%, but it's one of a very small handful of options compared to the actively-managed alternatives.
The Bottom Line
Overall, passive ETFs that let investors gain exposure to the tricky European region appear to make the most sense. The ETFs charge very reasonable fees, trade much like stocks during regular trading hours and have a number of different offerings to choose from. Actively-managed mutual funds don't appear to justify the higher fees, based on the fact that the funds generally underperform the respective index it's supposed to beat. There may be some options out there where individual managers can consistently beat their bogey, but for most investors ETFs offer the easiest, most cost effective options that effectively allow them to lock in the performance of the underlying index.
At the time of writing Ryan C. Fuhrmann was long shares of HP but did not own shares in any of the other companies mentioned in this article.