Globetrotting? 3 ETFs for Investing Overseas

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Investors have been rewarded for globetrotting so far in 2017, with major foreign stock indexes gaining more than 20% through mid-December. Joining me to share some perspective on investing overseas is Dan Sotiroff. He is an analyst with Morningstar.

Dan, thank you so much for being here.

Dan Sotiroff: Thanks for having me, Christine.

Benz: Dan, let's talk about the base case for U.S. investors investing overseas. They have been rewarded with good returns this year. It's not always the case. But let's just talk about why investors ought to at least give some consideration to having globalized portfolios.

Sotiroff: The case for international diversification, I think, really there's two big points to drive home there. With the asset allocation models in the passive investing that's been proliferating over the past decade or so, you have a less than perfect correlation between U.S. stocks and foreign indexes. It's high, but it's less than perfect. There's some small benefit there at the asset class level for investors.

The second point really is, you get a broader opportunity set outside of just U.S. stocks. You have to remember here, 50% of the global market cap is really overseas right now. There's a much bigger opportunity set that investors can take advantage of, many, many more companies overseas than there are in the U.S. Those are really, kind of, the two big diversification advantages you can get from international stocks.

Benz: There's also the issue that many companies, especially multinationals, are really global in scope, whether you are investing in a U.S. company or a foreign company.

Sotiroff: Right. That's correct. In that regard, small-cap stocks also tend to have more economic ties to their local regions, I guess …

Benz: Home market. Yeah.

Sotiroff: …yeah. Exactly. Getting into like a core all-cap fund is a really good idea to get that extra sort of economic exposure to other countries.

Benz: I want to get some of those picks later on. But first, let's talk about some of the major trends that have shaped foreign markets, how they have evolved over the past couple of decades.

Sotiroff: It's important to point out, markets change on a short-term basis for any number of reasons. It's really hard to determine why. But like you said, if we go back over the past few decades, really last 30 or 40 years, what you've seen happen, you know, late '80s or early '90s, Japanese stocks accounted for 50%, 60% of a typical foreign index. Subsequently they haven't performed as well as most investors know, and that's been driving a lot of these international funds and international indexes with not great returns compared to U.S. stocks. That's really been the story over the past couple of decades.

The good news is that now because Japan has not performed as well as many other markets that international indexes are now more diversified than they have ever been going forward. It's been kind of a double-edge sword, I guess, if you want to say. That's really, really the big thing that's changed.

Benz: Japan is shrinking in importance. How about going forward, when you think about major changes that U.S. investors investing overseas should expect? What are some things to have their radar?

Sotiroff: That was what I was going to get at here is, what we want to do is take a forward-looking perspective on this. The foreign stocks, developed markets specifically, are more diversified than ever. I think if you look at what's going on in emerging markets, China has become a really big, prominent part of a lot of emerging-market indexes. Right now, you're around 25% to 30%, depending on the fund and the index that you are looking at, that's pretty typical. The other thing we had earlier this year was MSCI now, they are going to start including A shares in their EM Index.

Benz: Let's just unpack what that is. That's China A shares. Let's talk about what they are and MSCI is going to include them in its emerging-markets Index.

Sotiroff: Those are shares that are more specific to the Chinese market and they haven't really been accessible up to this point …

Benz: To U.S. investors.

Sotiroff: … to U.S. investors in a very efficient manner. But there are now avenues that a lot of these indexes can use to get access to them. They are going to become a bigger part of these indexes. As we look forward, China is already a bigger portion of these indexes. That's just because of China's growth over the past two decades or whatever. They are going to be adding in local shares now, these A shares. We don't know really where China's market cap is going to go in the future. There's a couple of things to look for there that generally signal that China could become an even bigger part of some of these indexes.

Benz: You alluded to the idea of investors maybe wanting to look, perhaps they should look at some sort of a broad foreign stock index that does encompass large-caps as well as small-caps. Do you have any sort of specific ETFs or funds that would recommend to investors looking for broad global exposure?

Sotiroff: There's kind of two ways you could go about doing this, I think. If you're looking at developed markets, again, we kind of like an all-cap core type fund, Vanguard FTSE Developed Markets Index ETF, the ticker symbol is VEA; broad diversification, large to small-caps, and it only charges 7 basis points right now. That's a great fund. If you are looking for more of a total international type of exposure, so EM plus developed markets, Vanguard has another fund in that space called Vanguard Total International Stock ETF, the symbol on that is VXUS. iShares has a very close competitor to that. Slightly different index, slightly different composition, but basically the same idea. It's the iShares Core MSCI Total International Stock Fund. Those both charge 11 basis points, so very close competitors. Both of those would be great picks.

Benz: OK, Dan. Thank you so much for being here to share your perspective.

Sotiroff: Sure. Thank you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.