3 Views On Best Way To Own Int'l Equities

International equity ETFs have already attracted nearly $40 billion in fresh net assets in the first quarter of the year alone, and demand for exposure to foreign equity markets continues to be strong.

Fading enthusiasm over the new U.S. administration’s ability to implement reform, as well as strong performance outside the U.S., are some of the factors fueling this demand.

Consider that the frontier-focused iShares MSCI Frontier 100 ETF (FM), for example, has shelled out about three times the returns of the SPDR S&P 500 (SPY) year-to-date. The developed-market ex-U.S. fund iShares MSCI EAFE ETF (EFA) and the emerging market iShares Core MSCI Emerging Markets ETF (IEMG) are also outperforming SPY this year, as the chart below shows: 

Chart courtesy of StockCharts.com

We asked ETF strategists for their views on international equities right now, how they go about accessing this space, and for some of their favorite ETFs. Here’s what they said:

Ben Lavine, CIO, 3D Asset Management; Hartford, Connecticut

We manage global equity ETFs, with MSCI ACWI serving as our primary benchmark. For global equities, we allocate at the regional level, and then at the smart-beta or factor level.

For regional allocation, we split the global markets between U.S., ex-U.S. developed, and emerging. We believe in global diversification, so it makes sense to have some allocation to each region, although we will vary the allocation based on perceived risk/reward.

Currently, we are overweight ex-U.S. markets versus the U.S. market, and overweight global small-cap versus large-cap.

We primarily invest in single- and multifactor ETFs. We believe multifactor ETFs make more sense when the ETF covers multiple regions, so we tend to look at multifactor ETFs for ex-U.S. developed and emerging markets rather than the U.S.

Our global equity ETF portfolio currently has allocations to the Goldman Sachs ActiveBeta International Equity ETF (GSIE) and the First Trust Emerging Markets Small Cap AlphaDex Fund (FEMS) for multifactor coverage of the ex-U.S. developed and emerging market small-cap markets, respectively.

For ex-U.S. single-factor exposures, we currently allocate to the iShares Edge MSCI Intl Value Factor ETF (IVLU) and the FlexShares International Quality Dividend Index Fund (IQDF) for more targeted value and yield exposures, respectively.

For ex-U.S. small-caps, we hold the WisdomTree International SmallCap Dividend Fund (DLS), which also has targeted exposure to yield.

Finally, we hold the FlexShares Currency Hedged Morningstar EM Factor Tilt Index Fund (TLEH), which tilts toward Fama/French value and size factors within emerging markets and is also U.S.-dollar hedged.

Gary Stringer, president & CIO, Stringer Asset Management; Memphis, Tennessee:

We tend to focus on mid- and large-cap names when considering foreign equity markets. Liquidity is always a key concern for us, so emphasizing larger names helps alleviate some of that concern in these foreign markets, which tend to have less trading volume than the U.S. equity market.

It’s important to remember that accounting standards differ overseas, so we have some concerns over earnings reporting. As a result, we tend to favor dividend payers. Nothing says “earnings consistency” like a nice, stable and growing dividend. We look at other “smart beta” strategies as a complement to our foreign dividend orientation.

Finally, we split our foreign exposure between developed markets and emerging markets, while avoiding frontier markets. Again, liquidity is a concern for us, and we find less liquidity in frontier markets than just about anywhere else. And that’s in addition to the political and other risks associated with frontier markets.

We consider emerging markets to be a tactical, short-term decision due to their heightened risks compared with developed markets. The current lofty valuation levels reduce potential returns relative to risk, so we find emerging markets unattractive at this time.

Foreign currency exposure is always a consideration when investing in foreign equity markets. The recent U.S. dollar slump is temporary, and we expect the U.S. dollar to regain strength primarily on divergent central bank policies. However, we do not see the U.S. dollar rallying like it did two years ago, so we have hedged only a portion of our foreign currency exposure.

Right now, we like the WisdomTree International Equity Fund (DWM) and the Goldman Sachs ActiveBeta International Equity ETF (GSIE) for our core foreign equity exposure.

Ben Doty, senior investment director, Koss Olinger; Gainesville, Florida

If you’re trying to gain a "neutral" exposure to international stocks, a good proxy is the MSCI ACWI ex USA Index. The first decision is how much of a nonhome bias a portfolio will have—a minimum of 25% is reasonable, especially since international stocks make up about half of the investable universe in terms of public market capitalization.

An ETF such as the iShares MSCI ACWI ex US Index ETF (ACWX) or the SPDR MSCI ACWI ex US index ETF (CWI) can accomplish this simply.

At our firm, however, we prefer to disaggregate a "neutral" exposure into several different investments that can add to the return outcomes of an international asset allocation. For example, we have tilts toward value stocks, infrastructure stocks, emerging market stocks and international small- and midcap stocks.

These tilts will likely earn long-term returns that exceed that of foreign developed large-cap stocks. These exposures are typically easy and inexpensive to acquire. Broad emerging market exposure, for example, can be had through the Schwab Emerging Markets ETF (SCHE) at a cost of only 0.13%. We invest in SCHE.

Since many ETFs don’t have a very long history, it’s important to have an underlying index history rich enough to observe relative return and risk. In international investing, it’s important to know what and why you’re buying, more so than it may be in domestic markets.

In SCHE, for example, there is substantial exposure to financials and energy. Some investors may not like that. Instead, they may prefer an ETF with more exposure to consumer goods and the so-called rising middle class in emerging markets.

Smart-beta investing works in international markets as much as buying low increases the likelihood of higher future returns, even though smart-beta investing in foreign stocks is not packaged in enough ETF structures as of yet.

Contact Cinthia Murphy at [email protected]