Yield, Please (Hold the Europe)

While European leaders try to move forward with a plan to address the sovereign debt crisis, there is plenty of uncertainty as to what lies ahead. Uncertainty begets market volatility, so risk-averse investors looking for exposure to international stocks might want to consider lower-volatility funds with relatively lower European exposure.

To generate a list of all exchange-traded funds that hold international equities and less than 50% exposure to European equities, we used this screen in Morningstar Office (a similar screen can be performed in Principia, minus the Sortino ratio criterion):

US Broad Asset Class = International Equity
And Equity Region Greater Europe < 50

As a point of comparison, the developed-markets MSCI EAFE Index (Europe, Australasia, and Far East) has a 66% exposure to European stocks and the MSCI ACWI ex-US (All Country World Index, ex-US) has a 50% exposure to European stocks.

Next, we added a screen for yield and eliminated ETFs that held REITs:

And 12 Mo Yield > 3
And Global Category does not equal Real Estate Sector Equity

Finally, we screened for volatility:

And Sortino Ratio 3 Yr (Mo-End) > 0.4

International equities tend to be more volatile than U.S. equities, especially in the short term, because of currency effects. Over the past three years, certain categories within international equities have experienced high volatility but strong performance as well. Instead of using standard deviation or the Sharpe ratio as screens, which penalizes both upside volatility and downside volatility, we used the Sortino ratio, which is a measurement of return per unit of downside risk. It is similar to the Sharpe ratio in that it has the same numerator (the return of the portfolio minus the risk-free rate) but instead of using the portfolio’s standard deviation as the denominator, the Sortino ratio uses the standard deviation of negative returns only. In simpler terms, the Sortino ratio only considers downside volatility as risk. For this screen, we looked for funds with three-year Sortino ratios greater than 0.4—again, as a point of reference, the Sortino ratio for the MSCI EAFE Index and MSCI ACWI ex-US was 0.09 and 0.14, respectively.