Indexing – International Edition (7/1/2014)

Back by popular demand, I’m going to continue looking at different areas of ETF market. I have had several requests to review International stock index options and that’s what this post will focus on. Besides, with the World Cup in full swing everybody’s thinking global!

Exhibit 1 summarizes major players and the important data points for the World and International categories. My picks are highlighted in gray. I addressed major decision factors in the prior post, but there are a few others that are particular to foreign stocks:

  • Exposure to Canada and South Korea – depending on the index tracked, some ETFs in the same category will include or exclude these countries so I’m showing % weight for reference
  • Inclusion of Emerging Markets in World ETFs but not in traditional “foreign” stock ETFs, such as EFA
  • Small cap exposure – early competitors tracked mostly large stocks with some midcaps. Newer funds do include small caps and I prefer using those.

Exhibit 1

17-11

Review & Picks by Category

World – these ETFs split roughly 50/50 between U.S. and International stocks based on current market value. However, due to home country bias, most U.S. investors typically have only about 30% in foreign stocks so you need to be aware of this difference in composition. Note that these funds allocate about 7% to Emerging Market stocks.

Vanguard is a clear winner here with low expense ratio and nice coverage of small and midcap stocks. It also has 5 times as many holdings as the iShares competitor. SPDR is not a good option here with tiny AUM and no trading volume.

World Ex US – this category takes the domestic stocks out but has exposure to both developed and emerging international stocks. VXUS is the best option in this category. It has lowest expenses, highest number of holdings and good exposure to small/mid stocks. Confusingly, VEU is a similar fund from Vanguard but it is missing small caps. It’s a similar story for the two iShares options. IXUS is another strong competitor based on MSCI index.

Developed – this is where the issues with Canada and South Korea come in. FTSE indices count Korea as a developed country while MSCI as an emerging one. Also, both VEA and iShares products exclude Canada. So if you want a fund that does include Canada, you have to use Schwab or SPDR options (both have 7+% weight). Overall, I like IEFA in this category for its number of holdings and broad market cap exposure.

Did you notice anything mindboggling about this lineup? Blackrock’s iShares has two entries here.   There is EFA with 0.34% price tag, 900 holdings and mostly large cap portfolio. And then there is IEFA costing 0.14%, holding 2,400 stocks and broad market cap exposure. Yet, despite all of IEFA advantages it has $2.3 billion in assets versus EFA’s $55.8 billion! There is absolutely no way to explain this other than investor complacency!!!

Emerging – offers exposure to developing countries such as China, Brazil, India and South Africa. For the same reasons as before, I like IEMG here. Also, you’ll get the right Korea exposure by combining it with IEFA (but no Canada).

Once again, comparing two iShares options is surreal. Somehow EEM is able to hold on to $38 billion in assets with a ridiculous expense ratio of 0.67% versus $4.5 billion for IEMG. EEM was the original ETF in this category and it started off charging 0.75%. When Vanguard entered the fray with VWO (originally at 0.25%), iShares lost a lot of assets so it responded by slightly cutting expense ratio and then introducing IEMG ten year later. So the completion does work to some extent, but still-massive EEM assets highlight investor inertia.

Small Cap – you might want to use these funds if you already have investments in large international stocks through existing ETFs (or actively managed funds). Here I like VSS for its broad portfolio, but note that it does include emerging markets unlike the competitors.

Performance Factor

Note that I didn’t use historical performance at all when selecting the funds I like the most. I would suggest you make the decisions based “fundamental” factors of low expenses, number of holding and exposure to the broad market cap spectrum. If you pick based on trailing performance, you might select funds that underperform going forward. For example, in the small cap category VSS 3-year return of 6.1% is way behind SCZ’s 9.9%. But this is entirely due to emerging markets underperformance during the period and as that reverses (and it will at some point!), SCZ will lag. In fact, it’s behind VSS by 3.7% so far this year.

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2 thoughts on “Indexing – International Edition (7/1/2014)

  1. Mike McGinley

    One reason EFA and EEM may have more assets than they should is due possibly to investors not wanting to sell due to unrealized capital gains.

    Reply
  2. Denis S Post author

    Hi Mike. That’s a very good point. I agree that it might account for some of it, but hard to believe that all $56 & $38 billion is in taxable accounts with large gains.

    Reply

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