So far, we’ve covered some tricks and traps for diversifying your portfolio’s equity allocations across Canada and the US, which is a great start, but why limit yourself to North America? In this blog/video, we’ll go overseas to further diversify your portfolio by adding ETFs from other developed markets around the world. This time, we’ll zero in on three broad market ETF contenders, including:
Once again, each fund’s icon has a small Canadian or U.S. symbol to indicate whether the ETF is traded on the Canadian or U.S. stock exchanges. Marked with a symbol. As we’ve been discussing, there are trading costs and tax ramifications depending on which exchange you tap.
Like our North American funds, these three international equity ETFs have been around for years, with IEFA first launched in 2012. XEF debuted a year later, and VIU followed shortly after.
Next, there are cost comparisons. Similar to the US equity ETFs from our previous blog/video, the US-listed IEFA has a lower expense ratio than the VIU or XEF that trade on Canadian stock exchanges. All else being equal, IEFA’s lower costs should enable its index to track more closely than either XEF or VIU.
IEFA has accumulated more assets than any listed fund in Canada. Its benchmark may give IEFA a slight edge in tracking its underlying international equity index more fully, and better reflect its diversified holdings.
Speaking of indices, VIU tracks the performance of the FTSE Developed All Cap X North America Index, while both XEF and IEFA track the performance of the MSCI EAFE IMI, or “investable market index.”
Now, many new acronyms and terms have been added to these code names. Let’s pause for a moment and unpack them:
“FTSE” stands for “Financial Times Stock Exchange”. This is the partial name of the index provider, FTSE Russell. “MSCI” is an acronym for another index provider, “Morgan Stanley Capital International”. And EAFE stands for “Europe, Australia and the Far East”, which are the developed countries that the MSCI index tracks.
The terms “All Cap” and “Investable Market Index” or “IMI” are terms specific to FTSE Russell and MSCI. These indices track the performance of large, mid and small cap companies. In other words, they are all “broad stock market indices”.
All these target indices are weighted by market capitalization. This means their large- and mid-cap stocks explain each fund’s performance, with small-cap stocks contributing the rest. And since these broad equity ETFs don’t specifically target micro-cap companies, microcaps contribute little to each fund’s bottom line.
Like the US, international stock markets have less exposure to the Canadian stock market’s financials, energy and commodities sectors. This provides additional sector diversification for Canadian investors.
In addition to helping us diversify across sectors, the international indices tracked by these ETFs include thousands of individual companies, providing additional diversification to global investors.
VIU’s FTSE index includes more companies than the MSCI index, followed by XEF and IEFA. Much of this difference can be explained by how each index classifies different countries’ markets as “developed” or “emerging.”
For example, FTSE classifies South Korea as a developed country, while MSCI still classifies it as an emerging market. The same is true for Poland, but with much less impact due to its smaller weight in the index.
This means VIU (which tracks the FTSE index) tracks hundreds of additional South Korean and Polish companies, while MSCI-tracking XEF and IEFA exclude them.
Even with their market classification differences, both indices have enjoyed similar performance since 2003. All else being equal, we expect that moving forward in the long run.
Apart from providing important global diversification, each of these international equity ETFs has delivered positive long-term returns since their inception. However, their long-term performance includes gut-wrenching periods. For example, in the early days of the Covid-19 pandemic, they each lost nearly 30% of their value. None of these ETFs were around during the global financial crisis, but a comparable fund lost more than 50% of its value in Canadian dollars during that time. That’s it iShares MSCI EAFE ETF (EFA).
I’m not recommending you when to diversify in and out of international equities! Long story short, you’re more likely to get it wrong than right, and lose the benefits you wanted to begin with. Rather, I tell you this so you can prepare to bear these kinds of losses when they happen, and they do happen from time to time. Remember: these periodic risks are essentially the entry price you pay so you can reap the long-awaited rewards of the global market.
In our next blog/video, we’ll show you how foreign withholding taxes can take a bite out of your international stock returns. See you soon!