Adviser Soapbox
ETF Hunting With Shotguns And Rifles
Carl Delfeld, Chartwell Advisor 11.13.06, 4:35 PM ET
A common question I get asked at conferences and workshops is whether investors should use broad-based international exchange-traded funds or country-specific ETFs to play international growth? Many financial advisers advocate the lower-cost, broad-based international ETFs over country ETFs, but you can easily shoot yourself in the foot by being penny-wise and pound-foolish.
The answer, of course, depends on what type of investor you are. What is your risk profile? What are your return objectives? And what is the pattern of distribution in the ETF basket under consideration? I often use the analogy of a rifle and a shotgun. You don't go turkey hunting with a rifle, and it would be foolhardy to try to nail that trophy bighorn with a shotgun.
In general, if you are a long-term "buy and hold" investor, then perhaps a broad ETF will get the job done. But don't get all tangled up in the bush by basing your decision on the lowest-cost ETF. Study the options before making your choice.
The most popular broad international ETF on the market is the one that tracks the MSCI Europe, Australia and Far East Index, also known as the EAFE. This index contains 21 well-developed countries, and one ETF that tracks it is the iShares MSCI EAFE Index, with an annual expense ratio of 0.35%.
Sounds good – but the problem is that the countries' stock markets are weighted in the index and ETF by their value. Fifty percent of your money will go to two countries: Japan and the United Kingdom. Meanwhile, only 1% of your money will go to dynamic countries with great stock markets, like Ireland. The Singapore weighting in this basket is 0.77%, Austria is 0.58%, Hong Kong is 1.75% and Sweden is 2.46%.
Not a good move, especially this year, with the Japan ETF flat as a pancake and Singapore up 32%, Hong Kong up 19.5%, Sweden up 32% and Austria up 23%. These country-specific ETF bullets will cost you a slightly higher annual fee, but the added flexibility is well worth the cost.
The Vanguard Pacific ETF is another example of an ETF that absolutely requires looking under the hood. It looks like a shotgun, but it's actually a rifle. Investors may think they are getting broad exposure to the Pacific region, but 74% of the money in this ETF basket goes to Japan, with an additional 17% to Australia. With an annual fee of just 0.18%, bargain hunters might have been smiling when they bought it, and I have to admit that it does have 20% of its net assets in ten great companies like Toyota Motor, BHP Billiton and Honda Motor.
Still, it is an awfully big bet on Japan, and if you are looking to tap into robust Asia-Pacific growth, keep this ETF in your holster and fire away with the iShares FTSE/Xinhua China 25 Index, up 46% so far this year; Singapore, up 32%; Malaysia, up 22.5%; Australia, up 22%--not to mention more dicey markets like Indonesia, which is up 58% this year.
In emerging markets, of course, putting too much powder behind one country can blow up in your face. This is why ETFs that track the MSCI Emerging Markets index may be the best strategy for many investors. The iShares (EEM) ETF gives you a nice balance, with roughly 16% exposure to South Korea, 11% to Taiwan, 10% to Brazil, 10% to China, 10% to Russia and 9% to South Africa. The Vanguard Emerging Market ETF has similar country weightings but has an annual fee of only 0.30%, compared to 0.75% for the EEM.
There are also other options out there, such as the 11 new Wisdom Tree international sector ETFs and the global sector ETFs, which normally have about half of their baskets in foreign stocks. Depending on the stakes, you might also consider getting a guide to increase the likelihood of bagging your game. After all, it wouldn't be smart to go hunting in foreign territory without taking someone along who knows the terrain.
Carl Delfeld is President of the global advisory firm Chartwell Partners and editor of http://www.chartwelladvisor.com/. He served as a director on the executive board of the Asian Development Bank during the administration of President George H. W. Bush, was a consultant to the U.S. Treasury and U.S. Congress and is the author of The New Global ETF Investor.
