International

International ETFs are an obvious complement to US broad market ETFs in a balanced portfolio by rounding out exposure to the global economy with positions in developed economies.

A handful of solid, well-priced ETFs give broad exposure to mostly large or mid-cap stocks in stable, transparent markets. The most popular is iShares MSCI EAFE ETF (NYSEArca:EFA), which tracks the popular MSCI Europe Australasia Far East Index (EAFE) of advanced economies. Most other broad international funds include small amounts of emerging markets. SPDR MSCI ACWI ex-US ETF (NYSEArca:CWI) and iShares MSCI ACWI ex US ETF (NasdaqGM:ACWX) both track about 45 countries in the Morgan Stanley All Country World Index. SPDR S&P World ex-US ETF (NYSEArca:GWL) and Vanguard FTSE All-World ex-US ETF (AMEX:VEU) round out the group with similarly comprehensive coverage. Most cost about 0.15% more than similar US ETFs, reflecting slightly higher costs of exchanging currency and dealing with foreign regulators.

Like US equities, international has rebounded smartly since the 2008 Crash. Still, international ETFs have trailed the US (represented here by SPY, the S&P 500) notably over the past 3 years reflecting not so much confidence in the US but concern for Europe and Japan:

Seeking better returns elsewhere makes sense when a) economic prospects abroad appear better than in the US, b) valuations of foreign stocks look cheaper than in the US, and c) the dollar seems overvalued vs. the euro and yen. With Europe none of these seem likely. At least an argument can be made for Japan being cheap.

European countries which dominate international ETFs (Germany, France, England) are not themselves in trouble, but they are intertwined with smaller ones which are. Greece, Ireland, Portugal and more ominously Spain and Italy face structural deficits with little political will to trim government. While this may seem no worse than the US fiscal stalemate, many European countries in trouble have slower growth and higher debt/GDP levels. The existence of the Euro is not in question in our view as some have suggested, but investors are getting nervous. All these factors put pressure on the Euro which can lower investor returns when investment is repatriated into dollars.

Japan suffered an extraordinary one-time industrial slowdown in the Fukushima disaster, but production is rebounding steadily. Japanese equities are at historically fair valuations at about 13 Price/Earnings and 0.8 Price/Book Value. These compare favorably with US equities. The main questions for Japan are whether generally low growth of the past 15 years will persist and whether the yen will finally succumb to pressure of Japanese investors seeking better interest rates. Economists generally agree on the first, and some predict the second but with timing uncertain.

It should be emphasized that international in the ETF world does not include emerging markets such as China, India or Brazil. Happily, there are many funds to fill this gap.

International exposure historically has helped to lower overall portfolio volatility, but increased correlation has dampened this effect for over a decade. Most unfortunate is that correlation has been been particularly strong just when the investor least desired it, during stock market plunges.

International stocks can be played in various ways. The following ETFs make it easy at modest cost to filter for company size and growth/value characteristics:

• iShares MSCI EAFE Growth ETF (NYSEArca:EFG), annual fees: 0.4%
• iShares MSCI EAFE Small Cap ETF (NYSEArca:SCZ), annual fees: 0.4%
• iShares MSCI EAFE Value ETF (NYSEArca:EFV), annual fees: 0.4%
• SPDR Dow Jones Global Titans ETF (NYSEArca:DGT), annual fees: 0.5%
• iShares S&P Global 100 ETF (NYSEArca:IOO), annual fees: 0.4%
• PowerShares BLDRS Developed Markets 100 ADR ETF (NasdaqGM:ADRD), annual fees: 0.3%
• Vanguard FTSE All-World ex-US Small-Cap ETF (NYSEArca:VSS), annual fees: 0.38%

A number of funds select and filter international stocks based on proprietary formulas using fundamental financial ratios:

• PowerShares FTSE RAFI Developed Markets ex-US Small-Mid Portfolio ETF (AMEX:PDN), annual fees: 0.75%
• WisdomTree DEFA ETF (NYSEArca:DWM), annual fees: 0.48%
• WisdomTree International LargeCap Dividend ETF (NYSEArca:DOL), annual fees: 0.48%
• WisdomTree International MidCap Dividend ETF (NYSEArca:DIM), annual fees: 0.58%
• WisdomTree International SmallCap Dividend ETF (NYSEArca:DLS), annual fees: 0.58%

The following leveraged funds are strictly for short-term speculative trading:

• ProShares Short MSCI EAFE ETF (AMEX:EFZ), annual fees: 0.95%
• ProShares Ultra MSCI EAFE ETF (NYSEArca:EFO), annual fees: 0.95%
• ProShares UltraShort MSCI EAFE ETF (AMEX:EFU), annual fees: 0.95%