A Great All-Cap Foreign Stock Fund

The core of most investment portfolios should be constructed from broad, low-cost funds. The number of foreign stock funds that possess these characteristics has climbed over the past decade, and investors are no longer restricted to those that only hold large- and mid-cap stocks. All-cap foreign stock index funds, like SPDR Portfolio Developed World ex-US ETF (SPDW), also incorporate small caps into the mix, which can provide incremental diversification benefits. SPDW combines its wide portfolio with a low fee into an attractive, competitive package.

Morningstar’s new ratings framework, which places more emphasis on fees, has recognized this fund’s low expense ratio as a significant advantage over its peers. As a result of this updated analysis, we have upgraded its Morningstar Analyst Rating to Gold from Silver.

This fund tracks S&P Developed Ex-U.S. Broad Market Index, which includes large-, mid-, and small-cap stocks from 24 foreign developed markets, including South Korea and Canada. It weights them by market capitalization, an approach that benefits investors by capturing the market’s collective opinion of each stock’s value while keeping turnover low. Market-cap-weighting can be tough to beat because the market tends to do a good job valuing stocks over the long term. Occasionally, it will increase the fund’s exposure to expensive stocks when investors get excited about an area of the market. But this doesn’t undermine its long-term efficacy.

The portfolio’s exceptional diversification mitigates the impact of holding the worst-performing names. It owns more than 1,800 stocks and has only 9% of assets in its 10 largest names. Its regional composition looks modestly different from a typical fund in the category because it excludes emerging-markets stocks. But stocks from these regions account for about 6% of a typical peer’s portfolio, so ignoring them shouldn’t have a significant long-term impact on the fund’s category-relative performance. Its inclusion of small-cap stocks further improves diversification since many of these firms are more closely tied to their local economies.

The fund has posted solid performance over the 10 years ended in November 2019. During this period, it managed to beat the category average by 62 basis points annually while outperforming about two thirds of its category peers. The fund’s expense ratio ranks among the lowest in the category and should continue to provide a strong advantage.

Process
This fund has a broad portfolio that effectively represents the opportunity set available to active managers in the foreign large-blend Morningstar Category. It earns a High Process Pillar rating.

SSGA’s portfolio management team tracks the S&P Developed Ex-U.S. Broad Market Index (BMI). This benchmark holds large-, mid-, and small-cap stocks from 24 overseas developed markets that are available to international institutional investors. Eligible stocks must have a float-adjusted market capitalization of at least $100 million and an annual traded volume of at least $50 million over the previous 12 months. The index uses buffering rules around these thresholds to help limit turnover. It weights final holdings by their float-adjusted market capitalization and reconstitutes annually in September. The index allows new IPOs that meet selection criteria to be added during quarterly reviews in March, June, and December.

The final portfolio does not hold every stock in its benchmark index. Instead, the managers employ a sampling technique to match index performance. This reduces the need to trade smaller and less-liquid stocks, which reduces implementation costs.

This portfolio captures a majority of the available foreign market capitalization. It effectively diversifies stock-specific risk, with only 9% of assets in its 10 largest holdings. This also causes the portfolio to look similar to the average of its category peers in certain ways. Sector weightings look comparable, with financial and industrial stocks collectively representing one third of the portfolio.

Country and regional allocations aren’t far off the category average either. The fund modestly differs from its peers in this regard, but the gap doesn’t pose a significant threat to its category-relative performance. Eurozone stocks represent the largest regional allocation, at 26% of the fund, while Japan and the United Kingdom make up an additional 24% and 13%, respectively. The fund does not hedge its currency risk, so its exposure to currencies like the euro, yen, and pound can add to its volatility.

The fund’s selection universe doesn’t include stocks listed in emerging markets and Canada. Japanese stocks mostly fill this gap, which is consistent with diversified, foreign developed-markets indexes. The fund includes small caps but weights its holdings by market capitalization. So, it tilts more toward large-cap multinationals, with companies like Nestle, Toyota, and BP among its biggest names.

Performance
The management team has delivered sound index-tracking performance, but the fund’s total return underperformed more than one third of its peers in the foreign large-blend Morningstar Category over the 10 years through November 2019. Foreign markets performed poorly by historical standards over this period. Many of the better-performing strategies in the category built their success through more defensive portfolios. They tended to invest in relatively stable stocks or hold cash, which allowed them to better weather drawdowns than index-tracking funds like this one.

Stocks listed in Japan and the United Kingdom collectively account for more than 40% of this portfolio. Consequently, the performance of these two markets can have an outsize effect on performance. Over the past decade, Japanese stocks have been a tailwind while those from the United Kingdom were less advantageous.

This fund does not hedge its currency risk. Over much of the past decade, foreign exchange rates have subtracted from its performance because the U.S. dollar has appreciated against the foreign currencies represented in this portfolio. Foreign exchange rates tend to move in cycles, so an appreciating dollar will not always be a disadvantage. Over the long-run, the impact of foreign exchange rates on total return tends to wash out.

People
The day-to-day management of this fund falls under SSGA’s Global Equity Beta Solutions team. Its global footprint and trading processes are designed to enable low-cost transactions, supporting an Above Average People Pillar rating.

Michael Feehily and Karl Schneider are named managers on this fund. Feehily is the co-head of the Global Equity Beta Solutions team and has been with this fund since January 2011. He also serves as the chairperson for SSGA’s Trade Management Oversight Committee. Feehily has been with State Street since 1992 and joined SSGA in 2010. Schneider is a managing director of SSGA and the deputy head of global equity beta solutions for the Americas region. He has been a named manager on this fund since January 2015 and with SSGA since 1997.

The management team collectively take advantage of State Street’s global footprint. It can transact from trading desks in London, Hong Kong, and Boston, which improves its ability to conduct trades in the most cost-effective manner. The trading process is designed to strike a balance between costs and tracking error. Tracking error is heavily emphasized in the management process and is one of the key components of manager evaluation.