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