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The Evolution of Foreign Stock Index Funds

Daniel Sotiroff: Foreign stock index funds have evolved in a few good ways over the past two decades. They now cover a much wider range of markets, and fees have declined to a level similar as U.S.-focused index funds.

Low fees are a starting point when selecting a foreign stock index fund, as low fee index-tracking funds typically prove tough to beat over the long-run. Costs aside, there are some other things that separate good from great.

Foreign index funds come in many different cuts. Those that focus on single countries or regions often don’t provide great diversification. They may be dominated by a small subset of stocks, sectors, or currencies, which makes them more susceptible to these specific types of risks.

Broader portfolios that span multiple countries, regions, and currencies can help tamp down investors’ exposure to these perils. These index-trackers typically fall into two groups. The first targets stocks from overseas developed markets, while the second includes those from emerging economies and captures the wider foreign stock market.

Funds that track large-cap developed-market indexes, like the MSCI EAFE Index or FTSE Developed Ex-U.S. Index, are a great place to start. These benchmarks provide a high degree of diversification while capturing a majority of the available foreign market.

Over the past few years, a few fund providers have expanded on these stalwarts, and they now offer index funds with incremental diversification benefits.

Bolting on stocks from emerging markets is one such way to expand a fund’s reach. Companies listed on emerging-market exchanges can be riskier than their developed-market brethren, but they still represent a relatively small subset of the total foreign stock market. Including them in a foreign stock index fund as a market-cap-weighted component helps spread a fund’s assets over a much wider base without adversely impacting a fund’s overall risk.

Tight index-tracking is another key component of great index-tracking funds. Ultimately, index fund providers should deliver index performance less the fund’s expenses. There are some nuances to foreign markets that can throw that simple math off. But most major index fund providers have a handle on any potential issues that can arise.

Steady tracking also requires infrastructure, technology, and a well-managed team that can execute these strategies. These components are more difficult for individuals to evaluate, but they are components that drive our ratings for index-tracking funds.

All of these things considered, there is no shortage of great funds that focus on developed markets. Vanguard Developed Markets Index, iShares Core MSCI EAFE ETF, SPDR Portfolio Developed World ex-US ETF, and Schwab International Equity ETF check all of the boxes mentioned above while featuring some of the lowest fees in Morningstar’s foreign large-blend category.

Low fee total foreign market index funds are fewer in number. Vanguard Total International Stock Index comes in both mutual fund and ETF format, while iShares Core MSCI Total International Stock ETF is only available in the ETF wrapper. These Gold-rated funds track different indexes, but they have very similar portfolios and should provide very similar performance. They cover the entire foreign stock market, including emerging markets and small caps, while charging less than 10 basis points annually.

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