Long-term investors need international equity exposure. That’s the mantra repeated by the CFA Institute and by advisors everywhere.
A new fund, the iShares Core MSCI EAFE ETF (NYSEArca: IEFA) is marketed as an answer to this exact need. It covers developed markets outside of the U.S.
It helps to grasp the broader context on IEFA by holding it up to the largest ETF in the space—its sister fund, the iShares MSCI EAFE Index Fund (NYSEArca: EFA). EFA has a massive asset base of almost $37 billion, and its top-tier liquidity means that it's easy and cheap to trade—even for novices.
But for long-term investors, IEFA has two structural advantages over EFA. First, it has a much lower annual fee—0.14 percent vs. EFA’s 0.34 percent.
As a reality check, we at IndexUniverse harp on the fact low fees don’t necessarily mean low all-in costs.
And IEFA will indeed cost more to trade than EFA. IEFA is a brand-new fund still seeking traction with investors, while EFA is one of the most liquid ETFs on the planet.
That said, IEFA’s bid/ask spreads look manageable, so for long-term investors, the lower annual holding cost should more than offset trading costs.
IEFA’s second improvement over EFA is wonkier, but it matters.
Put simply, IEFA does a better job capturing the market. It reaches further down the size spectrum of companies to include small-caps.
That doesn’t mean it’s betting big on small firms. It simply holds them in marketlike proportion, meaning they make up something like 10 percent of the portfolio. In comparison, EFA and many other competing funds lop off these smaller firms.
Index investing means owning the market, with the direct implication that deviations from the market are effectively bets against it.
In this light, EFA bets against international small-caps by ignoring them. IEFA rights this wrong.
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