Foreign ETFs: Four Perspectives

08/27/2013 10:00 am EST

Focus: STRATEGIES

Philip Springer

Chief Investment Strategist, Personal Finance

It's only prudent for a diversified portfolio to have some exposure to foreign equities. For this exposure, we suggest ETFs, which let you invest in a basket of securities at low cost, providing instant diversification, suggests Philip Springer in Personal Finance.

Let's take a look at the world outside the US from four perspectives:

#1: A single ETF.

You can invest in non-US stocks with one vehicle. There are several attractive options.

Our favorite is Vanguard FTSE All-World ex-US (VEU). This all-in-one ETF combines broad diversification, a high yield (4.7%) and a rock-bottom expense ratio (0.15%).

The fund provides exposure to 46 developed and emerging markets, with 2,345 stocks weighted by market capitalization. Those from Japan and the UK take 32% of assets, and emerging markets account for 17%.

#2: Europe.

The Continent's financial and economic crisis is now in year six and the litany of woes isn't pretty. Still, Europe is home to many high-quality multinational companies that pay good dividend yields and trade at reasonable valuations.

Vanguard FTSE Europe (VGK) offers the best combination of diversification among large and mid-cap companies in Europe's developed markets, plus low cost (an expense ratio of only 0.12%). Four nations account for 76% of assets: the UK, France, Switzerland, and Germany. Two weaker euro zone members, Italy and Spain, together comprise just 8%. The fund's current yield is a lofty 5.1%.

#3: Japan.

As hard as it is to believe, Japan's long-troubled economy now is growing faster than those of other developed nations, including the US. Japan's economy grew at a 3.5% annual rate in the first quarter of 2013.

Other positives include a new-found political stability and the government's commitment to ending the nation's chronic deflation, notably through the Bank of Japan's uniquely aggressive monetary policy that dwarfs that of our Federal Reserve.

The first of two ETF alternatives here is iShares MSCI Japan (EWJ). It provides broad exposure, with 300 stocks and a tilt toward large export-oriented and financial companies.

Like most ETFs, the iShares fund doesn't hedge its foreign currency exposure. This typically isn't a major problem. But a core goal of Japan's economic program is depreciation of the yen. When that occurs, as it has in 2013, it reduces investment returns for foreign investors.

The other alternative is Wisdom­Tree Japan Hedged Equity (DXJ). As the name suggests, it's the better alternative when the yen is declining. This fund is up 23% so far in 2013, compared with 15.5% for the iShares ETF.

Another difference: The fund's holdings are weighted by their dividend payouts, while EWJ is weighted by market capitalization.

#4: Emerging markets.

The struggles of long-overhyped emerging markets have been well documented of late. Actually, emerging markets collectively have lagged US stocks by a wide margin for over five years.

The biggest problem, particularly for the BRICs (Brazil, Russia, India, and China), has been slowing growth, as exports and prices of most commodities have suffered in a sluggish global economy.

Our favorite is battle-tested WisdomTree Emerging Markets Equity Income (DEM). It holds some 200 high-yield emerging-markets stocks, weighted by their annual dividend payouts.

The fund's four biggest country allocations, accounting for 61% of assets, are Russia, China, Taiwan, and Brazil. The dividend focus helps to offset the emphasis on BRICs.

The current yield is 4.1%. We recommend WisdomTree Emerging Markets Equity Income as the best single ETF for emerging markets.

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