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Our Picks for Global ETF Exposure

Wed, 14 Nov 2012

Low-volatility strategies look attractive for developed-markets exposure today, says Morningstar's Sam Lee.

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Video Transcript

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Sam Lee. He is the editor of the Morningstar ETFInvestor newsletter. We're going to look at some of his favorite picks for exchange-traded fund global investing. Sam thanks for talking with me.

Sam Lee: Thank you for having me here.

Glaser: So let’s look at some good options for investors who are looking for that global exposure. Let’s start in Europe and some of the developed markets. What are some of your favorite funds there?

Lee: So right now I like minimum-volatility ETF's. So the iShares MSCI EAFE Minimum Volatility ETF is probably my favorite place to be right now for developed markets. All it does is it tries to screen for lower-volatility stocks, and historically in the back test it’s had about one third to one fifth less volatility in the market-weighted EAFE Index.

Low volatility is a really compelling strategy because it seems over the long run low volatility strategies will offer you above the market return, but with about less risk. So I think it’s really promising strategy to apply especially in the more volatile markets right now.

Glaser: So if you’re little bit worried about the sovereign debt crisis, you are worried about the potential for disruption there, that might provide a little bit of protection?

Lee: Yes, so this is more of a cherry on top. If you're really worried about the sovereign debt crisis in Europe, I would not advise you to try to time the market in and out, to shift from more aggressive to defensive equities. Not very many people can do that successfully. So I think the minimum-volatility ETF is a good strategic choice. It's something that you’re going to hold for multiyear periods, not something that you're going to hold just for one year or until the sovereign debt crisis cools down.

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Glaser: Well let’s take a look at emerging markets then. I know for ETFs they opened up emerging-markets investing for a lot of investors to some places that maybe weren’t accessible before. What should people know about emerging-markets ETFs? What should you look for in picking a fund?

Lee: So one thing that people should understand is that faster economic growth does not always translate into faster stock market price appreciation, and there are good reasons for that. One is people who invest in these emerging markets tend to overbid; they tend to bid up the prices of these fast-growing country stocks.

Right now this does not seem to be the case. In fact, emerging-markets equities are trading a discount relative to the U.S. They yield about 3%, whereas the U.S. yields about 2%. So you do have that prospect of faster price appreciation, and you have reasonable valuation. So I'm actually OK with Vanguard MSCI Emerging Markets ETFs. So just the broad market calibrated ETF. But I think you can actually do a step better than that and go with WisdomTree Emerging Markets Equity income, (ticker) DEM. It charges a little bit more, about 40 more basis points. And there is higher turnover, but I think that the value tilt and the dividend tilt are very useful especially in the emerging markets because emerging markets are countries in which accounting standards are not as clear, as uniform, and their balance sheets are not as transparent. And not only that, but management may not be as well-aligned with shareholders as they are in U.S. companies.

So if you own dividend-paying stocks, then you’re buying stocks in companies where management’s interests and your interests are more well-aligned.

Glaser: So how about any country-specific funds. Are those just too concentrated to make sense for a lot of investors?

Lee: I would say most of the case they are too concentrated. There are reasonable places, especially if you’re looking for undervalued equities such as Spain, France, and Germany. This is only if you are a very, very brave investor, but I think there is a good long-run case for investing in those distressed markets because that’s how you get rewarded, you take on more risk.

Glaser: What are some of those funds?

Lee: So most of them are in the iShare suite, the iShares MSCI Japan, iShares MSCI France, and iShares MSCI Spain.

Glaser: So we’re talking about frontier markets, what some people say are the new emerging markets. Is this an area that just really is just too far out there to be part of a kind of reasonable asset allocation or are there funds that would make sense in this space?

Lee: I don’t think there are any frontier-markets ETFs that are worth investing and right now at this stage, primarily because frontier markets are so illiquid. What you want when you’re dealing with illiquid asset classes is you want a really good active manager who can be very patient and selectively buy stocks. You don’t want mechanical indexes in those markets.

So anything such as high-yield bonds, you probably want to shy away from too much of a rigid indexed approach. Micro-cap stocks are another good example of a place where indexing doesn’t work too well, and I would also lump in foreign frontier-markets stocks in that category, as well.

Glaser: Well, Sam, thanks for your picks today.

Lee: Thank you.

Glaser: For Morningstar, I am Jeremy Glaser.

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