International investing is an effective way to diversify your equity holdings by providing a means to profit from faster growing economies around the world. In 2009, for example, iShares MSCI Brazil Index Fund (EWZ), posted a return of 124.46% as Brazil experienced economic growth and recovery bolstered by its energy industry. One-year returns do not mean that this fund - or the Brazilian economy, for that matter - will repeat that same performance this year or at any point in the future, but it does illustrate the potential for explosive growth in certain international markets as recovery from the global economic crisis continues.
Broad Exposure or Targeted Trading?
The amount of international exposure that’s right for you depends upon your risk tolerance and your level of involvement. If you want to take a more hands-off approach, you are better off with a broad-based international equity fund that provides exposure across several countries. For a more active approach, you can pursue a single-market ETF, as long as you are willing to track your investment on a daily basis.
In general, most investors would do best to include a mixture of both developing and emerging markets in their international equity holdings. This can be accomplished through ETFs specifically targeting these sectors.
Vanguard’s European ETF (VGK) tracks an index of companies located in the major markets of Europe, with about a third f the fund’s holdings in January 2010 comprised of United Kingdom companies and with lesser amounts devoted to companies France, Germany, Switzerland, and Spain. SPDR DJ Euro Stoxx 50 ETF (FEZ), by contrast, is similar in structure, but holds a slightly different mix, with 38% of its holdings in France and 26% in Germany. The point is there are several ETFs targeting non-U.S. developed economies for investors to consider.
You can take a similar broad-based approach to emerging markets with ETFs that focus on multiple countries across one or several regions. For example, iShares MSCI Emerging Markets ETF (EEM) targets several emerging markets, including (as of January 31, 2010) Brazil (accounting for 13.95% of the fund’s holdings), South Korea (13.23%), Taiwan (10.62%), China (10.41%) and South Africa (8.04%), followed by Hong Kong, Russia, India, Mexico, Israel, and others. A similar fund is Vanguard’s Emerging Markets ETF (VWO) with top holdings (as of January 2010) of China (17.6%), Brazil (16.1%), South Korea (12.9%), Taiwan (11.1%), and India (7.7%), followed by Russia, South, Africa, Mexico, Israel, and others.
For a somewhat more focused strategy, investors can take the well-known BRIC approach that targets the combination of Brazil, Russia, India, and China, which has long been the gold standard of emerging-marking investing. This brings to mind BRIC funds such as iShares MSCI BRIC (BKF), Claymore/BNY Mellon BRIC (EEB), and SPDR S&P BRIC 40 (BIK). Although these funds target the same countries, each takes a slightly different approach, as the table below shows:
Single-Country Promise and Pitfalls
Although trading BRIC ETFs remain popular, risk-tolerant investors have been taking more of an active, hands-on approach, seeking out the newest emerging market ETF opportunities with funds that focus on individual countries such as Russia, Vietnam, Thailand, Turkey, and South Korea. Before jumping into a single-country strategy, however, you need to be aware of some serious potential downfalls as well as the promise for strong returns.
As you add single-country exposure to your portfolio, be mindful of the potential for overlap if you also hold a regional ETF. Overlap occurs when a broader-based fund includes exposure to a particular sector or market, which is then increased by a more targeted ETF: for example, let’s say you owned Vanguard’s Europe ETF (VGK). You would want to know that nearly 12% of the fund’s holdings are in Germany before you added a narrow ETF such as iShares MSCI Germany Index Fund (EWG).
Overlap is not the only concern when it comes to single-country investing. The more targeted the approach, the more carefully you have to watch for sudden developments that could turn a potential growth story into a worrisome scenario. For example, in February 2010, economic problems in Greece captured the headlines because of fears that the country could default on its debt payments. Although the news focused on Greece, investors also looked for other potential trouble spots in Europe, which put Italy in the crosshairs. In response, iShares MSCI Italy (EWI) came under pressure. In February 2010, it was the second-worst performing Europe ETF for the previous three months (see Figure 6-1). Only iShares MSCI Spain (EWP), where the Spanish housing and banking situation had caused investor consternation, fared worse.
A market is hot, and then it is not. Therefore, the investment opportunities you pursue in a single country, particularly those in emerging markets, are often reaped over a period of months. These are not “buy and hold” investments for an auto-pilot type of investor. They require close monitoring on a daily basis.
On the other hand, a diversified international portfolio allows you to benefit more broadly from markets outside of the U.S., without exposing you to undue risk in a single country. For most investors, this is the way to go.
Currency ETPs are generally more volatile than broad-based ETFs and can be affected by various factors which may include changes in national debt levels and trade deficits, domestic and foreign inflation rates, domestic and foreign interest rates, and global or regional political, regulatory, economic or financial events. ETPs that track a single currency or exchange rate may exhibit even greater volatility. Currency ETPs which use futures, options or other derivative instruments may involve still greater risk, and performance can deviate significantly from the performance of the referenced currency or exchange rate, particularly over longer holding periods.
Commodity ETPs are generally more volatile than broad-based ETFs and can be affected by increased volatility of commodities prices or indexes as well as changes in supply and demand relationships, interest rates, monetary and other governmental policies or factors affecting a particular sector or commodity. ETPs that track a single sector or commodity may exhibit even greater volatility. Commodity ETPs which use futures, options or other derivative instruments may involve still greater risk, and performance can deviate significantly from the spot price performance of the referenced commodity, particularly over longer holding periods.