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ETF Investing for Beginners: International Equity

July 22, 2011 - 2 comments

In the third blog post of this series, we will look at how an investor can use ETFs to obtain International (including developed and emerging) market returns. Canadians investing abroad must also be aware of how foreign exchange fluctuations can affect their portfolio returns. There are products available that attempt to hedge away this risk, such as the iShares MSCI EAFE ETF (CAD-Hedged) (XIN). This currency hedged ETF could be used in conjunction with the unhedged Vanguard MSCI Emerging Markets ETF (VWO) to replace a portion of the unhedged Vanguard FTSE All-World ex-US ETF (VEU), while ensuring that the portfolio allocation to emerging markets is not diluted. Whatever the percentage amount of international equity that you would prefer to be hedged, simply multiply that amount by 0.35 to obtain the percentage that should be invested in VWO, and then subtract both amounts from your allocation to VEU.

Example:
A Canadian investor would like to place 50% currency hedging on the broad International equity component of their portfolio, while still maintaining the same breakdown between developed and emerging markets (74% and 26% respectively).  The investor currently invests the international equity allocation of their portfolio in the following ETFs:

  • 90% in Vanguard FTSE All-World ex-US ETF (VEU)
  • 10% in Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)

Using the international ETFs discussed above, what would be their new international equity allocation?

  • 50% in iShares MSCI EAFE (CAD-Hedged) (XIN)
  • 17.5% in Vanguard MSCI Emerging Markets ETF (VWO) → [ 50% × 0.35 = 17.5% ]
  • 22.5% in Vanguard FTSE All-World ex-US ETF (VEU)     → [ 90% - 50% - 17.5% = 22.5% ]
  • 10% in Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)

The new portfolio now has 50% of its international currency risk hedged away, while maintaining the 74% allocation to developed markets and 26% allocation to emerging markets.

For more information on currency hedging, please read An introduction to currency and currency hedging, by Mackenzie Investments. 

To obtain broad International equity market exposure, an investor could purchase a combination of the following:

  • 90% Vanguard FTSE All-World ex-US ETF (VEU) – this ETF tracks the FTSE All-World ex US Index, and is comprised of over 2,200 large and mid cap companies across developed and emerging non-U.S. equity markets around the world
  • 10% Vanguard FTSE All-World ex-US Small-Cap ETF (VSS) – this ETF tracks the FTSE Global Small Cap ex US Index, and offers broad exposure to over 2,500 mid and small cap companies across developed and emerging non-U.S. equity markets around the world. 

Broad international equity market exposure could also be obtained by investing 100% in the Vanguard Total International Stock ETF (VXUS), which tracks the MSCI All Country World ex USA Investable Market Index, and offers exposure to over 6,000 large, mid, and small cap companies across developed and emerging non-U.S. equity markets around the world, with an MER of 0.20%.

Depending on the investor’s appetite for risk, the allocation to VSS (which is comprised of mid and small cap companies) could be increased. This would increase the portfolio’s risk as well as expected return.

Once again, depending on the investor’s risk tolerance, a heavier allocation to value stocks could be considered (the definition of “value stock” varies among investors, but it is generally accepted that a high relative book to market ratio for a stock is a strong indicator). Similar to smaller capitalization stocks, adding more value stocks to the portfolio will increase the portfolio’s risk as well as the expected return. In the example to the left, iShares MSCI EAFE Value ETF (EFV) has been added to the mix, which tracks the MSCI EAFE Value Index, and is comprised of developed international large and mid cap value companies.  Since EFV does not include emerging markets, a separate allocation to Vanguard MSCI Emerging Markets ETF (VWO) has been added to account for the overall underweight. 


Source(s):  BlackRock, BlackRock Canada, Vanguard

 

 

 

By: Justin Bender with 2 comments.
Comments
  25/07/2011 3:38:34 PM
Justin Bender
Thank you for your comments, Moira. I agree, understanding the risks inherent in each product is extremely important, and perhaps better suited to the advice of an advisor. That being said, we are always looking for better ways to educate our readers on investing and financial planning concepts, and would certainly appreciate feedback from them on desired future blog topics.
 
  25/07/2011 2:45:35 PM
Moira Hudgin
An excellent and well researched article about a very complex subject. While you have made it easy to read and understand, this is certainly not topic for beginning investors. It is important to understand, as well, why you would want to consider investing in these various types of products. You need a good advisor to help you through that essential part of the portfolio review. I am sure you can do that step very well.
 



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