Low Volatility Abroad
This ETF allows investors to diversify into international stocks while keeping risk in check.
In the context of investing, volatility usually isn't a good thing. Sure, in theory, the market should compensate investors with higher expected returns for accepting greater risk that cannot be diversified, but it hasn't always turned out that way in practice. Historically, the most volatile stocks and bonds have offered the lowest risk-adjusted returns, according to a study by AQR principals Andrea Frazzini and Lasse Pedersen. In other words, incremental increases in risk have not been matched with commensurate improvements in return. More problematically, volatility tends to encourage the perverse tendency that investors have to buy high and sell low. It may also deter investors from adequately diversifying into international stocks.
While international stocks tend to be more volatile than their U.S. counterparts, much of this incremental risk comes from currency fluctuations. Currency hedging is one way to reduce this risk, but this approach also sacrifices the protection that foreign stocks can offer against a decline in the value of the dollar.
Alex Bryan has a position in the following securities mentioned above: EFAV. Find out about Morningstar’s editorial policies.