An ETF represents an interest in a portfolio of securities that often seeks to track an underlying benchmark or index and can be traded intraday like stocks.
Through Mercato, you have access to a wide range of ETFs that focus on different regions around the world.
Exchange-traded funds can be a great way to gain access to international markets that can oftentimes be challenging for individual investors to tap on their own. This ETF solution will explain why you may want to consider ETF investing, why ETFs could be a good tool to do it with, and some common pitfalls to avoid.
There are a few reasons why investing abroad may be a good idea. The first is that historically it has been a good way of improving your risk-adjusted return. That is to say, investing in international stocks could give you better results over time, without taking on a lot more risk. Another plus is that international markets have over time had a lower correlation to large-cap U.S. indexes such as the S&P 500 than domestic small- and mid-cap stocks. This means that your international stocks aren’t tightly linked to the returns of what is likely the core of your portfolio. Finally, international stocks can be a hedge against inflation at home or a falling dollar.
Of course, there are downsides and risks to investing aboard, as well. Frontier and emerging-market stocks are much more volatile than domestic stocks or those in other developed markets. For example, funds invested in China, Brazil, and other markets can have double the volatility of the S&P 500.
Political risk is another issue that investors should grapple with before jumping in. If a country were to implement currency controls or otherwise block foreign capital from entering the stock market, the value of your investment could suddenly drop.
So if after weighing the pros and cons of international investing you decided to dive in, why might ETFs be a good way to do so? First off, international ETFs have the same attributes that make ETFs attractive investments in other venues. They are generally easy to use, liquid, transparent, and tax efficient. International ETFs are also generally cheaper than their open-end counterparts.
ETFs also give investors a wide breadth of choices to gain access to different markets. There are international ETFs that slice the market by geography (global, regional, and single country), market-cap, investment style, sector, and even investment themes (China Infrastructure). Buying these broader instruments can be much easier than trying to construct a portfolio on your own.
With all of these options it is critical that you understand what you are buying, and that the investment actually aligns with your investment objectives.
Take for example two funds that sound very similar but are likely to have very different returns. For example iShares MSCI EAFE Small Cap Index Fund (SCZ) and Vanguard FTSE All-World ex-US Small Cap ETF (VSS) may seem similar at first glance, but the former doesn’t include emerging market stocks, whereas the latter one does.
You should keep a close eye on trading costs. These expenses can easily weigh down investment returns. Choosing funds that are more liquid, using limit orders, trading on days when the overall market is less volatile, and, when possible, trading an ETF when its underlying holdings (the foreign ordinaries) are trading can help minimize costs.
It’s also important to realize that sometimes it doesn’t pay to go abroad. For example, if you were interested in making a global consumer staples spending play, you could choose between the iShares S&P Global Consumer Staples Sector Index Fund (KXI) and Consumer Staples Select Sector SPDR Fund (XLP). But because so many consumer products firms are global firms, these two funds sport a near-perfect three-year correlation of 0.95. Given that the international fund’s expense ratio is more than twice as much, it makes sense to keep your money invested domestically.
International ETFs can make a good addition to your portfolio. Just make sure you know what you own, that you understand the potential for much greater volatility in emerging- and frontier-market funds and that you keep trading costs to a bare minimum.