CFRA Research continues to advise a 15% allocation to international equities. However, investors should look beyond a broad market-cap weighted index approach, explains analyst Todd Rosenbluth in CFRA Research's The Outlook.

In the first 11 months of 2021, iShares Core MSCI EAFE (IEFA) and Vanguard FTSE Developed Markets ETF (VEA) pulled in a combined $24 billion and were among the more popular ETFs, regardless of investment style. These funds charge extremely low fees and provide exposure to the largest companies domiciled in developed markets outside of the U.S.

However, there are many ways to get international equity exposure using ETFs based on the fundamental attributes of the local companies, which could prove to be important, as CFRA expects global markets to remain volatile in the year ahead.

iShares MSCI International Quality Factor ETF (IQLT) owns companies with low debt leverage, stable year-over-year earnings growth, and high returns on equity. The fund owns approximately 300 stocks, equal to 10% of what’s inside IEFA, with heavier concentration in ASML Holding, LVMH, and Nestle.

Relative to IEFA, IQLT has a smaller stake in Japanese companies (15% vs. 24%), due in part to not owning Sony and Toyota Motor. IQLT has outperformed IEFA in the one-year and three-year periods ended November 30, despite charging a higher 0.30% expense ratio.

Vanguard International Dividend Appreciation ETF (VIGI) owns shares of large-cap international companies that have raised their dividends for seven consecutive years. The fund owns about 350 stocks, less than 10% of what VEA owns. At the country level, VIGI recently owned larger stakes in Switzerland (17% of assets vs. 7.6%) and Canada (12% vs. 9.5%), respectively aided by positions in Roche Holdings  and Toronto-Dominion Bank.

In addition, the fund invests in emerging markets, such as India (7.1%) and China (5.1%). VIGI has outperformed VEA in the one-year and three-year periods ended November 29, despite charging a higher 0.20% fee.

FlexShares International Quality Dividend Defensive Index Fund (IQDE) combines quality and dividend characteristics in one portfolio. The fund focuses on a company’s cash flow generation, profitability, and management’s efficiency, while limiting sector and country exposure.

For example, IQDE has just 12% of assets invested in Japan, far less than its peers, and includes shares of Taiwan Semiconductor and Tata Consultancy Services from emerging Asia along with European companies, including L’Oréal and Rio Tinto.

iShares MSCI EAFE Min Vol Factor ETF (EFAV) is another strong alternative for risk-conscious investors, as it owns shares of developed market companies that have demonstrated relatively low volatility.

The fund recently had more exposure to Japan (27% vs. 24%) and less exposure to the U.K. (9.7% vs. 15%) than IEFA, with Softbank among its larger positions. Like IEFA, EFAV does not have exposure to Canadian companies like some international equity funds do.

Investors should look to smart-beta ETFs for international equity exposure in an effort to reduce the risk profile of the international portion of their portfolios. However, it is important to look inside and understand the distinct country exposure each fund provides relative to market-cap weighted offering.

FlexShares Internationall Quality Dividend Defensive Index and iShares Edge MSCI International Quality Factor both earn our 4-STARS buy rating. Meanwhile, iShares Edge MSCI Min Vol EAFE and Vanguard International Dividend Appreciation earn our highest 5-STARS buy rating.

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