The buoyant American stock market may be blinding investors to better opportunities abroad.
Sure, the decade-old bull market at home has been a boon to investors, driven by technology giants like Amazon (AMZN), Apple (AAPL) and Microsoft (MSFT). The S&P 500 (.SPX) has beaten the MSCI All Country World Index in total annualized returns, by 13.5 percent to 8.8 percent, since 2010 to the end of 2019.
But that’s not to say overseas markets have been doing poorly.
In several years over the last decade, stock markets in other developed economies, including Denmark, New Zealand and Austria, have turned in better performances.
Investors whose portfolios are heavily weighted to giant American companies may think they’re getting overseas exposure because those companies earn revenue abroad, but that’s not quite the same thing as investing internationally. The United States stock market makes up about half of the world’s market value, so there are plenty of opportunities to shop elsewhere.
Those who would like to add some international flavor to their portfolios need to be aware of a downside. Overseas markets may underperform American stocks, hurting portfolios.
But if the outlook is for less favorable conditions at home, having some international exposure is a good way to balance things, according to Daniel Sotiroff, a Morningstar analyst. And funds that track international indexes make it possible to dabble in foreign markets relatively inexpensively, he said. “It’s a huge win for investors.”
It’s worth starting out by examining some of the major international indexes. They are similar, but they have some crucial differences. For example, the index makers, MSCI and FTSE, don’t agree on how to classify South Korea. The MSCI EAFE Index (.MXEA) (for Europe, Australasia and Far East) excludes Korea, along with the United States and Canada. In contrast, the FTSE Developed All Cap ex-U.S. Index includes Korea and Canada, but, as its name suggests, excludes the United States.
FTSE’s Developed All Cap ex-U.S. Index also holds many more stocks than the MSCI EAFE Index (3,873 versus 918), meaning it has smaller stakes in a bigger pool of stocks, magnifying the diversification effect.
Apart from that, both indexes have a bigger weighting to Japan and Britain than anywhere else, and the biggest sector representations are finance, industry and health care. The biggest individual holdings also tend to be similar, including Nestlé (NSRGY), Novartis (NVS), Toyota Motor (TM) and HSBC Holdings (HSBC).
The sector weighting is notable because American stock indexes tilt more to technology, Mr. Sotiroff said. And since technology stocks have high valuations and financial stocks have lower valuations, the overseas indexes look relatively attractive, by this measure.
There are a few ways investors can use these indexes to add international exposure to their portfolios. The first is by embracing the whole market.
The Vanguard Total International Stock Index Mutual Fund (VTIAX) tracks the FTSE Global All Cap ex-U.S., with top holdings including Nestlé, Alibaba Group Holding (BABA), Taiwan Semiconductor Manufacturing (TSM), Tencent Holdings (TCEHY), Roche Holding (RHHBY) and Samsung (SSNGY). Its one-year return was 21.5 percent as of the end of 2019.
The Fidelity International Index Fund (FSPSX), on the other hand, tracks the MSCI EAFE Index, with top holdings Nestlé, Roche, Novartis, Toyota Motor, HSBC Holdings and SAP. Its 1-year return is 22 percent.
For exchange-traded fund investors, the Vanguard Total International Stock E.T.F. (VXUS) tracks the FTSE Global All Cap ex U.S. Index. It was up 21.6 percent for 2019 and has expenses of 0.09 percent.
Then there is the iShares Core MSCI Total International fund (IXUS), which also tracks the MSCI All Country World ex-U.S. index. With an expense ratio of 0.09 percent, it was up 21.8 percent for 2019.
Much the same thing can be done with actively managed mutual funds. T. Rowe Price’s International Stock Fund (PRITX), for example, focuses on large companies in developed markets and some emerging markets. Top holdings include Thales, Essify, Taiwan Semiconductor, Takeda Pharmaceutical (TAK) and Alibaba. It was up 27.9 for 2019.
Investors who don’t want to combine investments in developed markets with those of emerging markets can split their portfolio into funds that focus on one or the other.
Emerging markets, which contribute about 15 percent of global market value, have higher risks because they often are in smaller economies with less infrastructure and legal and regulatory oversight. They also tend to have a lot of state-controlled companies, in countries like Russia and China.
The iShares MSCI Emerging Markets E.T.F. (EEM) gained 17.7 for 2019, with top holdings including Alibaba, Taiwan Semiconductor, Tencent, Samsung, and China Construction Bank (CICHY). Its expenses are 0.67 percent.
Invesco’s FTSE RAFI Emerging Markets E.T.F. (PXH) was up 16.2 percent for 2019, with top holdings including Taiwan Semiconductor, China Construction Bank, Lukoil (LUKOY) and Gazprom (OGZPY). Expenses are 0.5 percent.
If you’d prefer an actively managed fund, Fidelity’s Total Emerging Markets Fund (FTEMX) has expenses of 1.14 percent and was up 21.7 percent for 2019, with top holdings Tencent, Samsung Electronics, Taiwan Semiconductor Manufacturing, Alibaba and Meituan Dianping (MPNGF).
People who want to stick to developed economies could look at the Vanguard FTSE Developed Markets E.T.F. (VEA), which focuses on large companies in the consumer cyclical, financial and industrial sectors. It was up 22 percent for 2019 with a 0.05 percent expenses.
The SPDR Portfolio Developed World ex-US E.T.F. (SPDW), tracking the S&P Developed ex-U.S. BMI Index, is slightly more weighted to financials and industrials. It was up 22.3 percent for the year with expenses of 0.04 percent. And the Schwab International Equity E.T.F. (SCHF), which also focuses on bigger companies, gained 20.9 percent for 2019 with expenses of 0.06 percent.
A final strategy involves E.T.F.s that focus on stable companies that pay dividends. But there are many possible approaches, including funds that focus on developed markets versus those tilted toward emerging markets. Turnover in these various portfolios can be high, Mr. Sotiroff of Morningstar warns, so trading costs are higher.
The Cambria Emerging Shareholder Yield E.T.F. (EYLD) tracks a Cambria index that follows stocks with big payouts. It was up 21.8 percent for 2019, with top holdings Iteq, TransContainer and Zhen Ding Technology Holding (RBTK). Vanguard has the International High Dividend Yield E.T.F. (VYMI), which gained 18.3 percent for 2019, with top holdings Taiwan Semiconductor, Toyota, HSBC and Royal Dutch Shell (RDS/A).
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