Vanguard and State Street's two total international-stock funds look solid.
Until recently, there haven't been many broadly diversified international-stock exchange-traded funds to choose from. Two new funds from State Street Global Advisors and Vanguard have changed that, and they're a long overdue addition to investors' toolkits.
Not the Only Flame in Town
For more than five years, iShares MSCI EAFE
IShares MSCI EAFE does have some positive attributes. As my colleague Gregg Wolper points out in his analysis of the ETF, for a reasonable price iShares MSCI EAFE tracks the most recognized benchmark for non-U.S. stocks and provides instant diversification among many countries in several regions, as well as across different sectors. But the ETF and its benchmark also lack a couple things. The MSCI EAFE has virtually no small-cap exposure and ignores emerging-markets companies as well as those in Canada. Investors wanting to index the entire foreign market with ETFs have had to use emerging-markets or regional or single country funds to make up the difference, incurring more transaction costs and portfolio maintenance hassles as they did so.
Enter SSA's and Vanguard's new offerings: SPDR MSCI All Country World Index (ex-US)
State Street launched its ETF in mid-January; Vanguard rolled out its conventional fund and ETF share class last week. Though they track different indexes, both provide similar exposure to virtually the entire world outside of the United States, including both developed and emerging economies, and Canada. That makes them comparable to Vanguard Total International Stock Market
Both new funds should make great core holdings. Their portfolios should be pretty similar. Each ETF's index includes more than 2,000 stocks from all major sectors and industries in nearly 50 countries. The market-cap-weighted benchmarks lean heavily on the largest stocks in the world, such as energy giant BP
I'm excited about these new ETFs for the role they can play in a long-term portfolio, not because I think it's a great time to buy international stocks. Indeed, global markets recently gave us a sharp reminder of the risks of international investing (particularly emerging-markets investing) and the benefits of using a diversified approach overseas. On Feb. 27, when panic selling in China triggered a worldwide sell-off, many of the hot performing emerging-markets and sector ETFs for which people had been clamoring bore the brunt of the plunge. The market prices of single country and regional ETFs, such as iShares FTSE/Xinhua China 25
ETF market prices usually trade fairly close to the NAVs of their underlying holdings, but discounts and premiums can open up periodically, particularly in ETFs tracking narrowly defined or harder-to-trade market segments. China and emerging-markets funds certainly meet that description, which helps explain why the iShares FTSE/Xinhua China 25 and iShares MSCI Emerging Markets ETFs ended the day with startling discounts to their NAVs of nearly 9 and more than 4 percentage points, respectively.
Sticking with a more diversified international ETF that keeps most of its assets in more liquid stocks, such as SPDR MSCI All Country World Index (ex-US), minimized the damage and the discount. The all country SPDR's market price fell by more than 4% on Feb. 27, but its share price stayed within one percentage point of its NAV. Within a day the discounts on most of the hard-hit ETFs narrowed significantly, so they were more of a curiosity than a problem for long-term investors. The gaps, however, show that short-term investors who buy these risky ETFs thinking they could bail on the funds quickly in sell-offs could pay a steep price.
Time will tell if February's dip was a blip or a sign of what is to come. But with international stocks looking fairly valued at best after a multiyear rally, I'd rather stick with an all-encompassing ETF like those recently launched by SSgA and Vanguard and avoid the more risqué fare.
Disclosure: Morningstar licenses its indexes to certain ETF providers, including Barclays Global Investors (BGI) and First Trust, for use in exchange-traded funds. These ETFs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs that are based on Morningstar indexes.
Dan Culloton is a senior analyst with Morningstar.