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A Passport To Hot Markets


The Morgan Stanley Capital International Europe Asia Far East index, better known as the EAFE, is a handy proxy for international stocks. But if you own the EAFE, as you would if you invested in the second-largest exchange-traded fund (ETF), the $49 billion iShares MSCIEAFE (EFA), you wouldn't own the world.

Indeed, the EAFE map has some big holes. Right now, Canada's stock market and currency are booming—the Canadian dollar recently reached parity with the greenback—but it's not in the EAFE. Neither are major markets such as Mexico, Brazil, and Russia.

While the EAFE covers 21 developed nations, stocks from four countries—Britain, Japan, France, and Germany—make up 62% of the benchmark. That's because the index is capitalization-weighted, so the larger the value of a nation's market, the more weight it has in the index.

Global investors can correct this imbalance with one of many more specialized ETFs now being offered. "Until recently, if you wanted foreign stocks, you were trapped in EAFE," says Michael Krause, president of ETFResearchCenter.com, a resource for financial advisers and investors. Now there are 124 foreign-oriented ETFs, up from about 50 over the past year. These newer vehicles allow you to spread out geographically to Russia or India, say, or pluck stocks from various markets based on their characteristics—small cap, or even small-cap value or small-cap growth stocks. Some carve up the global markets by sectors, such as energy, health, and real estate, or by companies that pay dividends.

Are all of these funds necessary? That depends on your goals. Wall Street creates ETFs and leaves it to investors to figure out how to use them. "The EAFE is fine for what it is, but it's great to have more options," says Jim Wiandt, editor of the Journal of Indexes.

Here are some of the ETFs that can expand your portfolio's global reach.

EMERGING MARKETS

They're wild and risky, but you can't participate fully in the global economy without investing in such markets as China, Vietnam, and Turkey. As a group, they're up nearly 18% for the year and 44% over the last 12 months.

The big ETF plays in this category are Vanguard Emerging Markets ETF (VWO), iShares MSCI Emerging Markets Index Fund (EEM), and SPDR Standard & Poor's Emerging Markets ETF (GMM). The Vanguard and iShares funds use the same index, but right now, at least, they're not getting the same results. So far this year, the Vanguard ETF is beating the iShares 35% to 31%. Vanguard's expense ratio is 0.30%, vs. the SPDR's 0.60% and iShares' 0.75%.

Yet another way to marry emerging and developed markets is the Vanguard FTSE All-World ex-U.S. ETF (VEU). The fund tracks approximately 2,150 stocks in 44 countries, with a modest 0.25% expense ratio.

SINGLE-COUNTRY FUNDS

China is red hot; Shanghai stocks have doubled this year alone. Until recently, the iShares FTSE/Xinhua China 25 Index (FXI), which holds the 25 largest and most liquid stocks, has been the only pure play ETF for China. But the Journal of Index's Wiandt favors the new SPDR Standard & Poor's China ETF (GXC) because it has 126 companies. To him, that's more diversification and somewhat less risk. (Like BusinessWeek, Standard & Poor's is a unit of the The McGraw-Hill Companies.)

Similarly, if you want to bring Canadian, Mexican, or Brazilian stocks into your portfolio, you can get them with the iShares MSCI Canada, Mexico, or Brazil Index Funds.

SMALL-CAP STOCKS

Many investors associate emerging markets with small-cap stocks, but there are plenty of small companies in the developed markets, and they're not part of the EAFE. The new SPDR Standard & Poor's International Small Cap (GWX) has nearly 500 companies with market capitalization of less than $2 billion. They're spread around the globe, but Japanese, British, and Canadian companies together represent nearly half the fund.

DIVIDEND PAYERS

With a 1.8% Yield, the EAFE ETF is not a high dividend investment, and some new ETFs can help on that front. iShares Dow Jones EPAC Select Dividend Index Fund (IDV), launched in June, contains nearly 100 high-yielding stocks from the developed markets. So far, the distributions indicate a 5.2% annualized yield.

A different approach is WisdomTree International Real Estate Fund (DRW), which tracks an index of 224 dividend-paying companies whose main business is operating or developing real estate. All of them are in the developing markets.

By Lynn O'Shaughnessy


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