Low-Cost Comprehensive Coverage of Foreign Stocks

International stocks should occupy a place in any well-diversified portfolio. While there are many ways to get this exposure, a low-cost, broadly diversified index fund, like

IXUS is a solid fund for broad exposure to stocks listed in foreign developed and emerging markets. Its well-diversified, market-cap-weighted portfolio and rock-bottom annual fee set it apart from its foreign large-blend Morningstar Category peers, and support a Morningstar Analyst Rating upgrade to Gold from Silver.

The fund owns approximately 3,300 large-, mid-, and small-cap stocks across all developed markets (excluding the United States) and 23 emerging markets, covering nearly the entire investable market. It weights them by market capitalization, which promotes low turnover and skews the portfolio toward large multinational firms with global operations. Top holdings include names such as

Sector weightings here are comparable to the category average. Financial-services companies account for the fund's largest sector allocation, representing roughly one fifth of the portfolio. Large banks such as

Like most of its peers, the fund does not hedge its currency risk, which can hurt performance when the U.S. dollar strengthens relative to foreign currency and is a source of volatility. Over the trailing 10 years, nearly one fifth of the fund's total volatility came from currency fluctuations. The fund currently has significant exposure to the euro, Japanese yen, and British pound.

Since it was launched in October 2012 this fund has struggled to perform against many of its category peers. From its inception through September 2017, the fund has trailed the average of its surviving category peers by 2.2% annually. This is primarily because of the fund's above-average exposure to emerging markets. However, its cost advantage should give it an edge over the long term.

Fundamental View The fund's market-capitalization-weighting approach 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 reflects the composition of the market and promotes low turnover. And it effectively diversifies company-specific risk. The fund's top 10 holdings account for 8% of the portfolio, compared with the category average of over 27%. 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.

The fund's above-average exposure to stocks listed in emerging markets has hurt performance in recent years. The MSCI EAFE Index, which tracks foreign developed markets, has outperformed the MSCI Emerging Markets Index by 4.4% annually over the trailing five-year period through September 2017. Emerging-markets stocks currently account for 17% of the portfolio, compared with the 7% category average.

In addition to emerging-markets exposure, the fund also displays some notable differences in regional and country allocations. China has a disproportionately large total market capitalization among emerging markets. As a result, market-cap-weighted portfolios investing in emerging markets will have considerable exposure to companies listed in China. This also causes the fund to be underweight, relative to the category average, across developed European countries, including the United Kingdom. Despite these differences, Japan represents the fund's largest single-country exposure, accounting for nearly 16% of the portfolio, which is comparable to the category average.

The fund's significant exposure to companies in the U.K. 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, 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 diversify economic risk.

While economic risk should already be reflected in market prices, investors should be aware of their currency exposure if these economic events lead to changes in monetary policy. Central banks in the U.K., eurozone, and Japan are all using aggressive monetary policies to keep interest rates low in an effort to stimulate demand. If rates in those markets stay low while rates rise in the U.S., the U.S. dollar could strengthen, which would hurt the fund's performance.

Portfolio Construction The fund tracks an extensively diversified index that captures the entire investment opportunity set available to active managers. It effectively diversifies risk while promoting low turnover, and earns a Positive Process Pillar rating.

This fund tracks the MSCI ACWI Ex USA Investable Market Index, which starts with all stocks listed in developed (excluding the U.S.) and emerging markets that pass certain liquidity screens. The index then sorts these stocks by their free-float-adjusted market capitalization, and targets those representing the largest 99% by market capitalization, thereby including small-cap companies. The result is an index portfolio of approximately 6,000 constituents. The fund’s managers then replicate the index across large and mid-cap stocks, while selecting a representative sample of the remaining small-cap firms. This sampling approach helps reduce costs. The index is reconstituted semiannually in May and November.

Fees The fund charges an annual fee of 0.11%, which makes it one of the cheapest options in the foreign large-blend Morningstar Category, and worthy of a Positive Price Pillar rating. This fund's market-cap-weighted approach promotes low turnover and keeps transaction costs in check.

Alternatives

Investors concerned about the volatility that currency fluctuations can introduce might consider a currency-hedged ETF such as Bronze-rated Deutsche

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