The amount of international exposure that’s right for you depends upon your risk tolerance.
- WILEY GLOBAL FINANCE
International investing can be an effective way to diversify your equity holdings. While returns have lagged behind US markets, international ETFs provide diversification benefits as they tend to be less correlated to US equities.
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're willing to track your investment on a daily basis.
In general, most investors would do best to include a mixture of both developed 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 20% of the fund’s holdings comprised of United Kingdom companies and with lesser amounts devoted to companies Switzerland, Germany, and France. SPDR DJ Euro Stoxx 50 ETF (FEZ), by contrast, is similar in structure, but holds a slightly different mix, with 40% of its holdings in France and 26% in Germany. The point is there are several ETFs targeting non-US 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 July 6, 2022) China (accounting for 33% of the fund’s holdings), Taiwan (14%), India (13%), South Korea (11%) and Brazil (5%), followed by South Africa, Saudi Arabia, and others. A similar fund is Vanguard’s Emerging Markets ETF (VWO) with top holdings (as of May 31, 2022) of China (30%), Taiwan (18%), India (15%), Brazil (7%), followed by Saudi Arabia, South Africa, Thailand, and others.
For a somewhat more focused strategy, investors can take the well-known BIC approach that targets the combination of Brazil, India, and China, which has long been the gold standard of emerging-market investing. This brings to mind BIC funds such as iShares MSCI BIC (BKF). Although these funds target the same countries, each takes a slightly different approach.
Single-country promise and pitfalls
Although trading BIC 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 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'd want to know that nearly 13% of the fund’s holdings (as of May 31, 2022) are in Germany before you added a narrow ETF such as iShares MSCI Germany (EWG).
Overlap is not the only concern when it comes to single-country investing: You might be exposed to currency risk. Not only that, 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 March 2022, U.S. based Russia ETFs were halted indefinitely due to regulator concerns as the Russian stock market closed. It is unclear how this will be resolved but the most likely options are the ETF is delisted and liquidates, cashing investors out at a price close to zero, or the halt is lifted and normal trading resumes.
A market is hot, and then it's 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 US, without exposing you to undue risk in a single country. For most investors, this is the way to go.
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