International ETFs—How They Can Help Investors Diversify
- International stock ETFs can help you diversify across world markets easily and inexpensively.
- We'll explore the three types of international ETFs: developed-market, emerging-market and niche.
Exchange-traded funds (ETFs) are essentially index mutual funds that trade like stocks, and they're very useful for getting less expensive exposure to markets that might not otherwise be in your portfolio. One area where many investors look to ETFs is international stocks.
Some international ETFs are very broad, focusing on stocks in well-established countries across Western Europe, plus Japan and Australia. Others focus on a range of up-and-coming countries in Asia and Latin America. Still others focus on a single country or a subset of broader international markets, such as the stocks of smaller companies. Each of these could have a role in a well-diversified portfolio, but it's important to know what you're looking for.
Developed markets are countries with well-established economies and financial systems. The list typically includes the United States, Western European nations, Israel, Japan, Singapore, Australia and Canada. These countries are generally seen as having the most stable economies in the world, and investments in their stocks often form the core of a global equity portfolio.
A developed-market ETF usually tracks one of the three main types of developed-market indexes:
- Developed ex-US index: Indexes such as EAFE, FTSE World ex-US or S&P World ex-US include developed markets other than the United States (EAFE excludes Canada as well).
- Global/World index: Indexes such as Dow Jones Global Titans, S&P Developed Broad Market Index and FTSE Developed comprise all developed markets, including the United States and Canada.
- All-world index: These indexes, which often come in an "ex-US" flavor, include all investable countries in the world, both developed and emerging. Examples are the MSCI ACWI ex-US index and the FTSE All World ex-US Index. These indexes are not pure developed-market indexes, but have far more exposure to developed markets than emerging markets.
Too many acronyms?
Here's what they mean:
- EAFE stands for Europe, Australasia and Far East.
- FTSE is a British partnership between the Financial Times and the London Stock Exchange.
- MSCI is short for Morgan Stanley Capital International.
- ACWI denotes All Country World Index.
You can see more complete definitions of all the international indexes we mention below.
Emerging markets are countries with economies and financial systems that aren't quite as established as those in developed-market countries. Examples include China, Brazil, India and Eastern European countries. These countries are generally seen as having greater growth potential than developed-market countries, but with greater risk as well (including political risk).
To be well-diversified, your growth-oriented stock portfolio should include both emerging markets and developed markets. A good rule of thumb is to have 20-25% of your international stock allocation in emerging markets and the rest in developed, non-US markets.
Niche international ETFs
Many ETFs focus on a subset of the international markets. Some track a single country like the United Kingdom, Germany, Japan or China. Some focus on a region such as Europe or Asia, or a combination of countries like the BRIC nations (Brazil, Russia, India and China). Others focus on a particular part of a broader market, such as the stocks of smaller companies within developed-market countries.
These niche ETFs, by their very nature, provide less diversification than developed-market or emerging-market ETFs. What's more, the narrower the focus of a fund, the more likely it will see big ups and down in performance. A single country or region is likely to be more volatile than the international stock market as a whole, and smaller-capitalization stocks tend to have greater ups and downs than larger companies.
Taking action: How to find international ETFs
by the Schwab Center for Financial Research
Most of the major ETF companies (including iShares, SPDRs, Vanguard and Schwab) provide international stock ETFs, and Schwab clients can use the ETF screener to find candidates for further research:
In the Currently Selected Criteria pane, click either Int'l Equity ETFs—Broad Based or Int'l Equity ETFs—Regional to find international ETFs.
Broad Based ETFs typically invest in developed countries and some emerging markets, and fall under the following Morningstar categories: Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Value, and World Stock.
Regional ETFs invest in specific regions or countries, such as emerging markets, Pacific/Asia, Europe, Japan, or Latin America.
Use Fund Type, Inception Date, Total Assets, Average Volume, and Gross Expense Ratio to narrow your results. The screener defaults to non-leveraged, non-inverse ETFs with a total asset range between $20 million and $1 billion and an average 10-day volume between 50,000 and 10 million shares.
Click View Matches to see your results.
Using international ETFs in your portfolio
Investors have long used ETFs to fill gaps in their portfolios. If you have no international exposure at all, these ETFs can help you get that exposure at a low ongoing cost.
If you want only the largest, most financially developed countries in your portfolio, consider an ETF that tracks a developed-markets ex-US index. If you want to broaden your international holdings, you could pair this with an emerging-markets ETF, and perhaps a small allocation to a small-cap international ETF.
Alternatively, if you want broad international exposure in a single ETF, you could purchase an ETF that tracks an all-world ex-US index.
Regional, single-country and other niche ETFs tend to make sense for investors who already own some international stocks or funds and need to round out a portion of their portfolio where they lack exposure. Some investors use niche ETFs as a tactical bet on a specific area within the international markets. Of course, with such a narrow investment, it's easy to get it wrong. We suggest limiting such positions to a small portion of your portfolio, no more than you can afford to lose.
A note about international ETF prices
It's important to compare a fund's market price to its net asset value (NAV). NAV is the value of the ETF based on the stocks within its portfolio, and an ETF's price should usually be close to its NAV (you don't want to pay more for an ETF than it's really worth). However, some international ETFs may swing from trading below NAV one day to trading above NAV the next, and back again.
This is due to the timing of the NAV calculation. NAV is officially calculated once per day, and it's based on the closing prices of all of the stocks in the ETF's portfolio. International ETFs hold stocks that trade on foreign exchanges in countries like Japan, Germany and the United Kingdom. By the time the ETF calculates its NAV at the close of the stock market in the United States, the prices of the foreign stocks in the portfolio are stale by many hours because those markets are no longer open.
The ETF's market price reflects what investors feel would be happening to the prices of those foreign stocks based on news and events during the US trading day. So if the US market is down, for example, the ETF's official NAV for that day will likely end up higher than its price. At the next day's close, the NAV will likely move lower than its price because the foreign markets would have had a chance to absorb the news from the previous US trading day, and the cycle begins anew.
Don't be too concerned about differences between the price of an international stock ETF and its NAV—they're just out of sync by half a day. If the difference persists in one direction over time, however, you'll want to take a harder look at what's driving the discrepancy.
Investors should consider carefully information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.
Some specialized exchange-traded funds can be subject to additional market risks. Investment returns will fluctuate and are subject to market volatility, so that an investor's shares, when redeemed or sold, may be worth more or less than their original cost. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV).
All ETFs are subject to management fees and expenses.
International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks.
Due to the sector focus of the ETFs mentioned, they may experience greater volatility than funds with a broader investment strategy. They are not intended to serve as a complete investment program by themselves.
Leveraged ETFs seek to provide a multiple of the investment returns of a given index or benchmark on a daily basis. Inverse ETFs seek to provide the opposite of the investment returns, also daily, of a given index or benchmark, either in whole or by multiples. Due to the effects of compounding, aggressive techniques, and possible correlation errors, leveraged and inverse ETFs may experience greater losses than one would ordinarily expect. Compounding can also cause a widening differential between the performances of an ETF and its underlying index or benchmark, so that returns over periods longer than one day can differ in amount and direction from the target return of the same period. Consequently, these ETFs may experience losses even in situations where the underlying index or benchmark has performed as hoped. Aggressive investment techniques such as futures, forward contracts, swap agreements, derivatives and options can increase ETF volatility and decrease performance. Investors holding these ETFs should therefore monitor their positions as frequently as daily.
Charles Schwab Investment Advisory (CSIA) is a team of investment professionals focused on rigorous investment manager research. Clients can find CSIA's top picks for Schwab OneSource mutual funds and ETFs in the Schwab Mutual Fund OneSource Select List® and the Schwab ETF Select List™. Charles Schwab Investment Advisory, Inc., is an affiliate of Charles Schwab & Co., Inc.
The Dow Jones Global Titans 50 IndexSM measures the performance of the largest multinational companies. The index was created in reaction to increased market globalization, providing representation of companies headquartered in countries around the world. Fifty stocks are selected for the index, based on float-adjusted market capitalization, revenue and net income.
FTSE All World Index is the Large/Mid Cap aggregate of 2,700 stocks from the FTSE Global Equity Index Series, which includes large-cap, mid-cap and small-cap stocks from 48 countries. The All World Index covers 90-95% of the investable market capitalization.
FTSE Developed Index is the Large/Mid Cap aggregate of 1,958 stocks derived from the Global Equity Index Series. The index contains companies located in 24 developed countries.
MSCI All Country World Index (ACWI) is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. As of May 27, 2010 the MSCI ACWI consisted of 45 country indexes comprising 24 developed-market and 21 emerging-market country indexes. The developed-market country indexes included are: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom and the United States. The emerging-market country indexes included are: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
MSCI EAFE® Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States and Canada. As of May 27, 2010, the MSCI EAFE Index consisted of the following 22 developed-market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom. The EAFE captures about 85% of the investable developed-markets universe excluding the United States and Canada. The index has been calculated since 31 December 1969, making it the oldest truly international stock index.
MSCI Emerging Markets IndexSM is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets. As of May 27, 2010, the MSCI Emerging Markets Index consisted of the following 21 emerging market country indexes: Brazil, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
S&P Developed Broad Market Index is a subset of the S&P Global Broad Market Index (BMI), which covers all publicly listed equities with float-adjusted market values of $100 million or more and annual dollar value traded of at least $50 million in all included countries. The S&P Developed BMI includes stocks from the 26 countries classified by S&P as developed markets.
This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security or pursue a particular investment strategy. The types of securities mentioned herein may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.
Diversification does not eliminate the risk of investment losses.
Charles Schwab Investment Advisory, Inc., is an affiliate of Charles Schwab & Co., Inc.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.