Whether the U.S. lurches into recession or regains its footing, 2007 may not be the year to load up on U.S. stocks. Advisors may therefore wonder if they should move more client money overseas, particularly as European markets have removed themselves from U.S.-dollar influence by increasing exports to emerging markets such as China and India.

Let’s look at two international equity funds: AGF Funds Inc. ’s $1.7-billion AGF International Stock Class Fund and AIM Fund Management Inc. ’s $190-million AIM International Growth Class Fund.

The AGF fund’s returns have been consistent, producing first-quartile performance in three of the past five years. After posting an 11.7% return in 2004, it continued its solid performance in 2005, delivering a 10.4% gain. For 2006, its 33% return eclipsed both the benchmark MSCI EAFE index and the median fund in the category. That translates into a first-quartile, five-year compound return to March 31 of 9.6%, compared with the median fund’s 6.4%. The AGF fund was a 2006 Canadian Investment Awards winner.

The AIM fund has performed equally well in the past five years. Up 15.1% in 2004 and 11.5% in 2005, it jumped ahead in 2006, gaining 31.5%. This translates into an even stronger first-quartile, five-year compound return of 11.4% to March 31.

As a result, both funds receive strong risk-adjusted rankings from Morningstar Canada, with the AGF fund earning four stars and the AIM fund garnering five.

The AGF fund’s manager, John Arnold, has been a specialist in European equities since 1969. He spent several years with National Provident Institutions, then moved to London-based Crown Financial Management. He joined AGF 13 years ago and is now managing director of its Dublin-based subsidiary.

Arnold and co-manager Rory Flynn look outside North America for value stocks of all sizes that trade at a discount of at least 30% to the market’s price/earnings multiple, and that yield significantly more than the overall market. Typically, the stocks the team buys will be out of favour and held for the long term. Turnover is low and, although not a key driver of returns, management occasionally hedges foreign currency exposure.

In terms of asset allocation, about 6% of the AGF fund is in cash, with the balance in stocks. Despite the fact that Japan accounts for 24% in the index, the fund has no direct exposure there; its managers have not found attractive Japanese companies that are as efficient as those in Europe. Consequently, about 80% of assets are allocated to Europe vs 67% for the index.

Britain accounts for 22% of the AGF fund’s assets. There is also a 20% weighting in France, 15% in Italy, 10% in Spain, and smaller holdings in Germany, the Netherlands and Taiwan.

The AIM fund’s manager, Clas Olsson, joined AIM in 1994 as an international portfolio analyst after a career with the Swedish Navy, and took responsibility for the fund in 2000.

Stung by the tech meltdown several years ago, the fund revamped its growth and momentum strategy, with an eye to valuation. Olsson looks for com-panies with accelerating earnings growth, driven by improvements in the underlying business. He also looks for strong return on invested capital. Foreign currency exposure is unhedged, however, leaving the fund open to Canadian-dollar fluctuations.

About 12% of the AIM fund is invested in Germany, followed by an 11% weighting in Japan, 9% in Switzerland and 9% in France, with the balance distributed throughout the Continent.

There are few common names among the two funds’ bigger bets. The AGF fund tracks about 60 positions at a time, while the AIM fund can hold more than 100.

The AGF fund’s larger bet is in financials, at 62.5% of the portfolio — by far the highest allocation to the sector in the fund category and more than double the index weight. The overweighted position has been in place for several years, because the companies generally provide the highest yields available. The fund has no holdings in health care or information technology, and only a small holding in consumer stocks.

In terms of weightings, the AIM fund is a little light on financials and utilities, and tilted toward consumer and industrial companies.

The funds also have opposing risk profiles. With a five-year standard deviation of 12.6, the AIM fund’s volatility has been quite similar to that of the index, and it is considerably less volatile than its AGF counterpart. The AGF fund’s profile is by far the riskier of the two, producing an 18.7 standard deviation over five years, compared with the benchmark’s 12.3. This gap has closed in the past few years.

@page_break@The AIM fund’s five-year Sharpe calculation of 0.70 underscores the fact that it has outpaced the median fund over most five-year periods. Similarly, the AGF fund’s lower ratio of 0.43 reflects its volatility, prompted in part by the departure of its previous manager, Brandes Investment Partners LP, a few years ago. It should be noted, however, this has been mostly upside volatility.

Although the AIM portfolio’s average market capitalization has crept up in recent years, it still has a lower average market cap than most of its competitors, at the same time sporting a higher P/E multiple.

With the exception of the AGF fund’s higher market cap and dividend yield, its other portfolio measures are lower than those of the index and the category median.

The smaller AIM fund would seem to be the favourite of inves-tors interested in international exposure, particularly as it has outperformed its benchmark 82% of the time over all five-year trailing periods since its inception, according to Morningstar. But, with a 3.1% MER, the highest in the category, it faces a large annual hurdle that could affect future returns. IE