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Home>Research & Insights>Investment Insights>One of the Most Diversified Foreign-Stock Funds Available

One of the Most Diversified Foreign-Stock Funds Available

Vanguard Total International Stock ETF provides investors with a heavily diversified portfolio at a rock-bottom fee.

Daniel Sotiroff, 09/15/2017

Vanguard Total International Stock ETF VXUS is an excellent choice for exposure to stocks listed outside of the United States. It accurately represents the foreign investable universe and is well diversified across developed and emerging markets. An updated evaluation of its regional composition and cost advantage has improved our confidence in its ability to perform. These considerations support a Morningstar Analyst Rating upgrade to Gold from Silver.

This fund tracks the FTSE Global All Cap ex US Index and covers stocks listed in more than 40 countries. The broad reach of this index includes all stocks that land in the top 98% by market capitalization. Holdings are weighted by market capitalization, which helps mitigate turnover and the associated transaction costs. The inclusion of small-cap stocks gives this fund a modest tilt toward smaller firms and improves its overall diversification. The top 10 holdings account for only 8% of this fund's assets.

The market-cap-weighting approach emphasizes multinational firms that are large and profitable. Companies such as Nestle, Samsung, and Novartis are among this fund's top holdings. Sector and country allocations are similar to a typical fund in this Morningstar Category, with stocks from Japan representing the largest country allocation, at almost 18% of the portfolio.

The volatility of this fund has been in line with the category norm despite holding more emerging-markets stocks than many of its peers. And while the fund's greater exposure to emerging-markets stocks can cause its performance to diverge from its peers', its total and risk-adjusted returns landed in the middle of the category over the trailing three and five years through July 2017. But we remain confident that its cost advantage and representative portfolio will lead to strong category-relative performance over a full market cycle.

Vanguard recently cut the fund's expense ratio to 0.11% from 0.12%. This is among the lowest expense ratios in the category and should give the fund a durable edge over its peers.

Fundamental View
The composition of foreign index-tracking funds is different than those that invest in U.S. stocks and therefore can help diversify a portfolio of U.S. stocks. Because these funds hold companies that are not listed in the U.S., they can expand the investment opportunity set. Sector composition is also notably different from the broader U.S. market. This fund has higher allocations to firms from the basic-materials and financial sectors, and less in healthcare and technology compared with the Russell 3000 Index. That said, the correlation between the FTSE Global All Cap ex US and Russell 3000 indexes was high (0.89) over the trailing 10 years through July 2017.

This portfolio is broadly diversified across large-, mid-, and small-cap companies from outside the U.S. Holdings are weighted by market capitalization, which reflects the market's view of each stock's relative value and reduces exposure to stocks as they become smaller and cheaper. This approach emphasizes the largest stocks in the investable universe, and many of these firms are major multinationals with globally diversified revenue streams.

Despite the emphasis on large caps, this fund's broad reach includes small-cap stocks. These smaller firms tend to be more closely tied to their local economies than their larger counterparts and can help diversify risk. However, foreign stocks have struggled to keep pace with stocks from the U.S. following the 2008 to 2009 global recession. From March 2009 through July 2017, the FTSE Global All Cap ex US Index returned 12.1% annually while the Russell 3000 Index returned 18.1%. As a result, foreign stocks have lower valuation ratios than those from the U.S.

Daniel Sotiroff is an analyst, passive strategies research, for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc.

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