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One-Stop Shopping for Exposure to International Stocks

This iShares’ ETF has appeal, but investors don't have to go much further afield to find more-compelling options.

Morningstar, 08/26/2016

iShares MSCI ACWI ex US ACWX offers broad, market-cap-weighted exposure to large- and mid-cap stocks listed in foreign developed and emerging markets. It effectively diversifies risk, accurately represents its target market segment, and charges a 0.33% expense ratio, which is well below the foreign large-blend Morningstar Category average. But there are cheaper and even better-diversified alternatives, such as iShares Core MSCI Total International Stock ETF IXUS, which charges a 0.14% expense ratio.

As a result of its broad reach, the fund owns approximately 1,200 large- and mid-cap stocks. The fund employs a market-capitalization-weighting approach, which promotes low turnover and skews the portfolio toward large multinational firms with global operations. Top holdings include names such as Nestle NSRGYToyota Motor TM, and pharmaceuticals Roche ROG, and Novartis NVS. The fund excludes small-cap companies, so its holdings tend to have a larger average market capitalization than its peers. 

Sector weightings here are comparable to the category average. Financial-services companies account for the fund’s largest sector allocation, representing nearly one fifth of the portfolio. Large banks such as HSBC Holdings HSBACommonwealth Bank of Australia CBA, and Royal Bank of Canada RY are among the fund’s top 20 holdings. 

Since its inception in March 2008 through July 2016, the fund has trailed the average of its surviving category peers by 57 basis points, annualized. This fund’s performance relative to the category average is largely tied to the performance of its emerging-markets holdings. Emerging-markets companies make up approximately 16% of the portfolio, compared with the 7% category average. If it had included small-cap stocks, the fund’s performance would have been slightly better. Since the fund’s inception through July 2016, the fund’s benchmark (MSCI ACWI Ex USA) has lagged the MSCI ACWI Ex USA IMI, a broader index that also includes small-cap companies, by 40 basis points annualized, with similar volatility. 

Like most of its peers, the fund does not hedge its currency risk. This can hurt performance when the U.S. dollar strengthens relative to currencies, like the euro, Japanese yen, and British pound, where the fund has significant exposure. Over the trailing five years through July 2016, over a fourth of the fund’s total volatility came from currency fluctuations.

Fundamental View
The fund’s market-capitalization-weighting approach, and large- and mid-cap orientation, skews the portfolio toward large multinational firms. These companies tend to be more profitable and less volatile than their smaller counterparts. But the countries where these firms are listed are not necessarily indicative of the economic exposure they provide. This broad market-cap-weighted portfolio promotes low turnover and effectively diversifies company-specific risk. The fund’s top 10 holdings account for less than 10% of the portfolio, compared with the category average of over 25%. Yet, its weighting approach could tilt the portfolio toward names as they become larger and more expensive and away from firms as they become smaller and cheaper, which may have higher expected returns.

An above-average emerging-markets stake has hurt the fund’s performance in recent years and resulted in some notable differences in regional and country allocations. The developed-markets-focused MSCI EAFE Index has outperformed the MSCI Emerging Markets Index by 5.8% annualized over the trailing five-year period through July 2016. China has a disproportionately large total market capitalization among emerging markets. As a result, the fund has greater exposure to Chinese stocks than most of its peers. It also has less exposure to stocks listed in developed European countries, including the United Kingdom. Despite these differences, Japan represents the fund’s largest single-country exposure, accounting for nearly 20% of the portfolio, which is comparable to the category average.

The fund’s significant exposure to companies in the United Kingdom and Japan, both of which are dealing with economic headwinds, should be less of a concern for investors than it may appear. The U.K.’s recent decision to leave the European Union, along with Japan’s aging workforce and tremendous public debt, both have the potential to slow new investment and weaken demand. However, these risks should already be reflected in market prices. Additionally, a large proportion of holdings within these two countries are multinational firms with global operations that diversifies economic risk.

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