McCall’s Call: Winning Developed-Market ETFs

September 08, 2010

Who said developed-world equities are in the dumps? You just haven’t looked closely enough at ETFs canvassing single countries, such as
Canada
.

Investing outside of the
United States
was once looked upon as risky and only for those willing to take above-average risk. That’s not the case any longer and, in fact, I think the risk level in many foreign countries is now lower than in the
U.S.

Matthew D. McCallFor example, what makes Switzerland a riskier country to invest in versus the
U.S.
? Absolutely nothing. And as a matter of fact, investing in Switzerland is almost surely less risky when you consider its current stable government and 3.9 percent unemployment rate, compared with almost 10 percent in the
U.S.

This year, the
U.S.
market, as measured by the SPDR S&P 500 ETF (NYSEArca: SPY), is down about 1 percent. During the same time frame, ETFs that represent countries such as Sweden, Canada and
Switzerland
have been able to produce gains. It’s time for investors to seriously consider investing outside the
U.S.
when they’re building a portfolio of developed-country ETFs.

Neighbor To The North

One of the most overlooked investment opportunities in the U.S. is our neighbor to the north,
Canada
. The country known for ice hockey is also a powerhouse in terms of commodities and, critically, they were able to sidestep many of the real-estate-related banking issues the
U.S.
encountered over the last few years.

The iShares MSCI Canada ETF (NYSEArca: EWC) is composed of 101 stocks that are based in
Canada
with a heavy concentration on financials and energy. Combined, the two sectors make up over 60 percent of the total allocation of the ETF, and four of the top seven stocks are Canadian banks. The ETF is up 3 percent year-to-date and it has an annual expense ratio of 0.55 percent.

The Canadian ETF is an attractive complement to
U.S.
investments because of its exposure to the commodity sector and to financials. Commodity stocks—in particular, gold stocks—have been moving independently of the overall
U.S.
stock market. The Canadian financials have outperformed their
U.S.
counterparts and, as I noted above, are less risky.

Scandinavian Dream

The best-performing developed-country ETF is the iShares MSCI Sweden ETF (NYSEArca: EWD), with a year-to-date gain of 9 percent. The Scandinavian country best known for their beautiful people and meatballs also has a thriving technology sector. With 20 percent of the ETF invested in technology stocks, the fund is poised to take advantage of more high-tech growth.

The two largest sectors are financials and industrials, making up 27 percent each. The only concerns I have with EWD are that the top 10 holdings make up 63 percent of the portfolio and there are only 33 stocks in the entire ETF. Also, a third of the ETF is allocated to the top three holdings. But, what it lacks in diversification, it makes up for with performance.

The Neutral Investment

The iShares MSCI Switzerland ETF (NYSEArca: EWL) is up slightly this year, but has rallied 18 percent from the low in late May. During the same time frame, the Rydex CurrencyShares Swiss Franc Trust (NYSEArca: FXF) is up 15 percent and the S&P 500 is up a measly 2 percent.

The ETF is heavily concentrated in its top holding, Nestle, which makes up 21 percent of the allocation. The top 10 holdings account for 74 percent of the ETF and the security has a total of 38 stocks. The Swiss are often viewed as a neutral territory, and the Swiss franc and Swiss markets in general are often considered safe havens during times of turmoil.

Diversification Is The Key

Each year there will be winners and losers in the world of single-country ETFs. The three I mentioned above just happen to be on top this year, but may not be there in 2011. That’s why it’s imperative to build a diversified portfolio of developed-country ETFs when investing in the asset class.

I’m not suggesting an investor move completely out of the U.S.; however, if 70 percent of a given portfolio is in the
U.S.
, an investor should diversify into other developed countries to lower risk and ideally increase the potential reward.


Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a Ridgewood, N.J.-based wealth management firm specializing in investment strategies using ETFs.

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