This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Scott Kubie, chief investment strategist of Omaha, Nebraska-based CLS Investments.
International markets are finally starting to realize the potential for outperformance that has been there for years. So far this year, the MSCI ACWI ex U.S. is up 7.63 percent in dollar terms, putting it about 5 percentage points ahead of the S&P 500 Index.
For some investors who have struggled to hold international stocks through periods of underperformance, just seeing the broad index outperform is enough. For the more adventuresome, there are opportunities for outperformance in diversified-factor ETFs that could be used for a portion of their portfolios.
Based on changes in fundamentals and policies, international value stocks and companies buying back large portions of their shares represent attractive factors to emphasize in international portfolios.
To access those two phenomena in ETFs, there’s the iShares MSCI EAFE Value ETF (EFV | B-94) that represents international value stocks well, and the PowerShares International BuyBack Achievers Portfolio (IPKW | D-42) is the only ETF focused on international buybacks.
Quantitative easing (QE) programs in Europe and Japan are the big factors supporting these two ETFs. Because the programs achieved full force much later than the U.S.’ QE program, the U.S. program provides some direction on how international stocks should benefit.
Europe’s QE program has pushed the yields of many sovereign bonds below zero percent. Investors have pushed the euro lower in response to a lengthy period of expected low rates. The cheaper currency and encouragement of risk-taking will likely support the nascent European economic recovery.
Japan’s economy shows similar potential. This article examines three expected outcomes of QE. The first two outcomes support emphasizing value stocks, and the third focuses on buybacks.
Growth stocks often outperform value when their secular growth stories provide the only source of meaningful growth for companies. In periods when growth outperforms, value stocks are hampered by low growth in the overall economy, which constrains company sales. Over the last year, this trend has pushed growth stocks ahead of value stocks.
For example, the iShares MSCI EAFE Growth ETF (EFG | B-93) is up more than 5.90 percent over the last year, while EAFE Value is up less than 1 percent. Based on expectations for higher economic growth in Europe, some of this performance advantage should reverse.
Attractive yields provide a second reason to favor international value stocks. International value, based on Morningstar estimates, is expected to yield 4.03 percent. This compares favorably to 2.24 percent for EAFE Growth. Interestingly, the yield on EFV—the iShares international value-focused fund—is comparable or better than some dividend-focused U.S. ETFs.
For instance, the Vanguard High Dividend Yield ETF (VYM | A-95) is expected to yield 3.48 percent. In the U.S., high-yielding stocks outpaced the Russell 3000 over the last five years. As European investors react to low yields on bonds, the high yields available in value should be attractive. U.S investors may also find the higher yields abroad too luring to pass up.