Top Foreign ETFs

8/5/2013


The July 15 issue of the Forecasts featured our favorite U.S. stock exchange-traded funds (ETFs). This time around we picked standout international ETFs. The nine funds, each from a distinct category, boast reasonable expense ratios and solid performance.

Foreign ETFs typically offer improved trading flexibility, potentially better tax efficiency, and lower expenses compared to traditional international mutual funds. Investors seeking foreign exposure through ETFs should keep in mind the five tips below:

Review company, sector, and country exposures. Some of the largest and broadest ETFs are fairly concentrated, making them more aggressive than you might think. For example, nearly one-third of SPDR S&P International Dividend ($45; DWX) is invested in just 10 stocks. This top-heavy fund holds 22% in financials, and stocks hailing from Australia represent 26% of assets.

Gauge diversification benefits. Foreign funds can help mitigate the volatility of a mostly U.S. stock portfolio. But many international ETFs, particularly those slanted toward large-company stocks, generate returns more than 95% correlated with the popular MSCI EAFE Index, which contains mostly stocks from developed countries in Europe, Australia, and Asia. Over the years, the EAFE index has become increasingly correlated with large and midcap U.S. stocks. Investors should consider emerging-market or small-cap and midcap foreign ETFs, which may offer more diversification benefits.

Make accurate comparisons. Most fund returns are measured against the EAFE index. But about 17% of the index is invested Japan — the best-performing major market in 2013. Thus, a mediocre fund might look particularly good this year if it had an outsized weighting in Japan. Investors should compare fund performance to both index and peer-group returns.

Evaluate expenses carefully. Not all ETFs are bargains, and international funds can be relatively pricey, as many have expense ratios above 0.80%. In addition, because many foreign ETFs are strongly correlated to the EAFE index and tend to generate similar returns, investors should focus on the lowest-cost funds. Vanguard FTSE Developed Markets ETF ($37; VEA), a good all-purpose foreign ETF that invests mostly in large-company stocks, charges a tiny 0.10% annual expense ratio, versus a category average of 0.57%. 

Be aware of currency risk. Exchange rates can fluctuate sharply and unexpectedly, impacting ETF performance. Some funds hedge currency exposure to limit the impact of exchange-rate fluctuations. But hedging can be difficult and expensive. Moreover, a hedged ETF generally offers less diversification benefits. Unless you have a strong opinion that the U.S. dollar is likely to strengthen versus other currencies, an unhedged ETF is a better choice for most investors.

9 STANDOUT INTERNATIONAL ETFs
--- Total Return ---
Exchange-Traded Fund (Price; Ticker)
YTD
(%)
3-Year
Annual.
(%)
Expense
Ratio
(%)
Category
iShares MSCI EAFE Growth ($65; EFG)
8.9
9.2
0.40
Large-cap growth
iShares MSCI EAFE Small-Cap
($45; SCZ)
11.6
11.4
0.40
Small & midcap
blend
iShares MSCI EAFE Value ($51; EFV)
7.5
7.4
0.40
Large-cap value
Schwab Emerging Mkts. Equity
($24; SCHE)
(9.8)
0.1
0.15
Emerging markets
Vang. FTSE Developed Mkts. ETF
($37; VEA)
8.2
8.5
0.10
Large-cap blend
Vanguard FTSE Europe ETF ($52; VGK)
8.0
9.1
0.12
Europe
Vanguard FTSE Pacific ETF ($57; VPL)
8.1
7.8
0.12
Asia/Pacific
Vang. Total World Stock Index ETF
($54; VT)
10.8
11.3
0.19
World stock
WisdomTree Int'l SmallCap Div.
($55; DLS)
9.2
12.0
0.58
Small & midcap
value

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