Why International ETFs Are Luring Investors
Some advisors are turning to developed markets funds for global exposure.
International exchange-traded funds flows rose in the first five months of the year, as investors sought out one of 2022’s poorly performing sectors, according to LSEG Lipper data.
This year, investors are back.
“Investors embraced some of the deeply out-of-favor macro-classifications of 2022, injecting the largest amount of net new money so far this year into international funds,” wrote Tom Roseen, head of research services at LSEG Lipper.
So far this year, a significant portion of the inflows is going to European ETFs, which gained $9.7 billion, and international multi-cap core ETFs, picking up $9.6 billion.
Noel Archard, global head of ETFs and portfolio solutions at AllianceBernstein, said the ETF issuer saw increased flows in both active and passive international developed ETFs, around 20% this year versus about 10% to 12% in 2022. For equities alone, about half of the flows are going to foreign sector ETFs.
Brian Kraus, senior vice president for systematic ETFs at Hartford Funds, noted mean reversion and valuation are two big reasons investors are attracted to developed international funds after mostly shunning them during the U.S.’ decade-plus of outperformance.
International stocks are cheaper than U.S. equities, and especially cheap now, he said. Comparing the foreign -equity category against itself over the past three decades, shows international stocks are cheaper now than they’ve been 75% of the time.
Stocks can stay cheap and market leadership doesn’t have to change. However, Kraus explained that macroeconomic factors might make this time different, with inflation declining but remaining above trend, and a greater likelihood of a soft economic landing in the U.S. and other developed countries.
“All inflation measures are higher than their averages, but we're seeing some modest decline,” he stated. “That tends to be really, really good for international.”
Additionally, he said that international stocks tend to be more cyclical and can benefit from an early-stage economic recovery following a soft landing.
If the Federal Reserve pauses its rate-hiking cycle, it could weaken the dollar. A strong greenback during the Fed’s tightening cycle last year was one of the reasons developed international markets were under pressure.
How Financial Advisors Are Using International ETFs
Emerson Ham, co-founder of Sound View Wealth Advisors, said his firm is starting to wade back into international ETFs when they rebalance portfolios, after having little to no exposure for a decade. He’s encouraged by international markets’ improved returns this year, with MSCI EAFE up 6.8% through May.
Ham seeks broad-based developed international exposure and is using the iShares Core MSCI EAFE ETF (IEFA), citing its country and market cap diversity. He’s also started to use the Vanguard International Dividend Appreciation ETF (VIGI), noting that he’s a “big fan of dividend appreciation strategies.”
Gerald Goldberg, chief executive officer and co-founder of GYL Financial Synergies, said investors must understand how index providers classify international markets.
MSCI, used by BlackRock, labels South Korea an emerging market, while the FTSE Russell index, used by Vanguard, classifies South Korea as a developed market. He recommends staying within a certain family to avoid inadvertently excluding countries or regions.
Goldberg uses a mix of iShares and Vanguard funds depending on the client, including the Vanguard FTSE Developed Markets ETF (VEA) or the iShares MSCI EAFE ETF (EFA), two broad-based core funds. He also employs the foreign large blend fund, the iShares Core MSCI International Developed Market ETF (IDEV).
Passive ETFs may complement active strategies, such as using a growth ETF along with an active value strategy. One international growth ETF Goldberg has used is iShares MSCI EAFE Growth ETF (EFG).
Anthony Caruso, co-head of product specialists at Dimensional Fund Advisors, said international markets also add diversification to portfolios. Investors who continue to favor domestic markets may miss out on potential gains.
Although the U.S. dominated performance in the last decade, in the early 2000s, international markets, particularly emerging markets, vastly outperformed in the U.S. Picking which country or securities will outperform is difficult, he added.
“For us, the more diversified we are, the more reliably we can capture premiums like value, size and profitability that we'd look to target across our non-U.S. portfolios and U.S. portfolios,” he explained.
