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ETF Specialist

This Is One of the Broadest Foreign-Stock Funds Available

Vanguard Total International Stock ETF is an outstanding core foreign-stock fund.

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Foreign stocks provide access to a wider opportunity set than those listed in the United States, making them a key building block for constructing a well-diversified portfolio. A comprehensive fund like  Vanguard Total International Stock ETF (VXUS) provides an excellent base for building an allocation to non-U.S. stocks. It covers the entire investable market outside of the U.S., giving investors access to stocks of all sizes. The exchange-traded fund's ultralow expense ratio and market-cap-weighted approach curb the cost of ownership, providing it with a significant advantage over its more expensive rivals. It earns a Morningstar Analyst Rating of Gold.

The fund tracks the FTSE Global All Cap ex US Index, which targets stocks of all sizes from more than 40 overseas developed and emerging markets. It weights its holdings by market capitalization, an approach that benefits investors by capturing the market's consensus opinion of each stock's value while mitigating turnover. Markets usually get long-term prices correct, but they occasionally make mistakes. Investors can drive valuations up if they get excited about a particular area of the market, and market-cap-weighting will increase the fund's exposure to it.

Broad diversification mitigates the impact of the worst performers on the fund's overall performance. The portfolio includes more than 6,000 stocks, and its 10 largest names account for only 8% of assets.

Foreign-stock funds like this one can diversify a U.S. stock portfolio. The portfolio's sector weightings are comparable to its average Morningstar Category peer, and it allocates 10% more than the category average to emerging-markets stocks. But this modest gap shouldn't impact the fund's category-relative performance.

The fund's total and risk-adjusted returns were similar to the category average between its launch in January 2011 and November 2018. It remained fully invested, while its better-performing competitors were more defensive, giving them an advantage during this period of lackluster market performance. The fund's 0.11% expense ratio is a sizable cost advantage over most of its competitors. In a stronger market environment, its smaller cash balance should help its category-relative performance.

Fundamental View
Stocks listed in overseas markets can diversify a U.S.-centric portfolio. The fund includes stocks listed in both developed and emerging markets and captures most of the available foreign market capitalization. Its market-cap-weighted approach emphasizes the largest firms in the portfolio. Major multinational firms like Nestle, Novartis, and Samsung rank among its top holdings. Firms like these have global operations and diversified revenue streams, much like their large-cap counterparts listed in the U.S. Therefore, they don't provide clean access to the economies where they are headquartered. But this fund also includes small caps. Smaller firms tend to be more closely tied to their local economies and therefore improve the fund's diversification.

Market-cap-weighted funds like this one provide cost-efficient, diversified exposure to the opportunity set that active managers select from and make no active bets on specific regions, countries, sectors, or individual stocks. Market-cap-weighting essentially free-rides on the judgment of active investors. The allocation to each stock reflects their collective opinion about its relative value. Using this technique, a stock's weighting floats with its price changes and requires little turnover to maintain its desired exposures. Low turnover translates into low transaction costs.

The wide geographic reach of this portfolio provides access to a diverse range of countries and currencies. The fund has less exposure to European stocks than the category average and makes up for this difference with a greater allocation to those from emerging markets. Stocks listed in these countries carry some unique risks that are not present in developed nations. Some firms are partially owned by sovereign governments and may put political interests before those of public shareholders. Additionally, conducting business in some of these nations can be difficult because many emerging markets do not have the infrastructure and mature legal systems that are more common in developed economies.

Despite overweighting stocks from emerging markets, its sector and individual country weightings aren't far off the category average. Financial firms represent the fund's largest sector, at 21% of the portfolio. Stocks from eurozone countries account for 20% of the fund's assets, while Japan and the United Kingdom represent an additional 18% and 11%, respectively. This fund does not take measures to hedge its currency risk, therefore it has exposure to currencies like the euro, yen, and pound. Changes in the exchange rates between these currencies and the U.S. dollar can add to the fund's volatility.

Portfolio Construction
This fund tracks a comprehensive, low-turnover index of overseas stocks while capturing the market's collective opinion of each stock's value. It earns a Positive Process Pillar rating.

The managers employ full replication to track the FTSE Global All Cap ex US Index, which starts with all stocks listed in more than 40 countries across developed and emerging markets. It sorts this wide cohort by free-float-adjusted market capitalization and holds stocks that rank in the top 98% by market cap. The index uses buffering rules around the cutoff point to help mitigate turnover, and qualifying stocks are subject to liquidity screens to ensure that the index is investable. It weights the final holdings by market cap, which mitigates turnover and the related trading costs. The index reconstitutes semiannually in March and September.

Fees
Vanguard offers this fund through two low-cost share classes, so it earns a Positive Price Pillar rating. In November 2018, Vanguard closed the mutual fund's Investor share class and lowered the investment minimum on the Admiral share class to $3,000 from $10,000 ($3,000 was the minimum for the outgoing Investor share class). The Admiral shares and this ETF both charge 0.11%, which ranks among the lowest fees in the foreign large-blend category. The ETF led the fund's target index by 4 basis points annually over the trailing three years through November 2018. Securities-lending revenue helped the fund recover some its expenses, but investors should not expect this activity to produce long-term index-beating returns.

Alternatives
Gold-rated  iShares Core MSCI Total International Stock ETF (IXUS) (0.10% expense ratio) is a close competitor. It covers foreign stocks from developed and emerging markets its portfolio is nearly identical to VXUS.

 Vanguard FTSE All-World ex-US ETF (VEU) covers stocks from developed and emerging markets. But it does not hold small caps, so it is modestly less diversified than IXUS. It also weights stocks by market cap. Like VXUS, it charges 0.11% and has a Gold rating.

 SPDR Portfolio Developed World ex-US ETF (SPDW) also invests in stocks of all sizes but limits its holdings to those listed in overseas developed markets, including Canada and South Korea. It also weights holdings by market cap. Its 0.04% expense ratio makes it the cheapest fund in the foreign large-blend category, supporting its Silver rating.

Foreign-stock funds that hedge away currency risk can eliminate most of the volatility caused by foreign-exchange rates.  IShares Currency Hedged MSCI EAFE ETF (HEFA) tracks the large- and mid-cap-focused MSCI EAFE Index, and the managers use forward contracts to hedge foreign-exchange risk. The fund has a 0.35% expense ratio and a Bronze rating.

Silver-rated iShares Edge MSCI Minimum Volatility EAFE ETF (EFAV) (0.20% expense ratio) takes a different approach to reduce risk. Rather than hedge currency risk, it attempts to construct the least-volatile portfolio possible from foreign developed-markets stocks in the MSCI EAFE Index under a set of constraints. These include keeping country and sector weightings within 5% of the MSCI EAFE Index to promote diversification and capping turnover at 20%.

Daniel Sotiroff does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.