One of the most contentious points for passive buy-and-hold U.S. investors is with regards on how much international stocks (if any) should be held in a portfolio.
On one hand, you have investing legends like Warren Buffet and John Bogle who were both famously bullish on the U.S. market and held the bulk of their portfolios there. A study by Vanguard found that most U.S. investors held domestic equities at 79% of their portfolio for a significant home-country bias.
Still, the start of 2023 once again proved that investors chase the herd. As of March 28th, international ex-U.S. equities have outperformed domestic ones, with inflows to international equity ETFs sharply increasing. Let's examine the rationale for international investing and check out some ETF picks.
Why go international?
As I see it, the argument against international investing falls into two camps, both of which are rather illogical:
- "The U.S. market has historically outperformed over many market cycles!"
- "U.S. stocks have international exposure already thanks to globalization."
Let's debunk #1 first – while it is true that from 1995 to present, U.S. stocks beat international developed and emerging stocks on both a trailing and rolling return basis, there is no guarantee of this continuing. Investors who believe in #1 are falling prey to the hot hand fallacy. Repeat after me: past performance has no bearing on future outcomes.
Historically, Australian, and South African markets have all posted returns as high or higher than U.S. stocks, but nobody advocates for investing just in those countries. The U.S. might comprise 60% of the world market by market cap weight now, but regimes change. One can imagine the lost decades that the Japanese market is still stagnating after a period of global dominance.
Moving on to #2 – it's illogical to overweight U.S. equities simply because they do business overseas. According to this line of thinking, I could theoretically derive enough U.S. exposure by holding international stocks like Nintendo, Toyota, Samsung (KS:005930), which after all, do a significant portion of their business in America. This reasoning is preposterous.
As noted earlier, the U.S. market comprises 60% of the world. 40% is held in other countries, many of which are experiencing high GDP growth such as the BRICs countries of Brazil, Russia, India, China, and South Africa. Does it make sense to arbitrarily exclude 40% of the world's market cap weight? Will you pile into international stocks if the U.S. begins to stagnate, as it did from 1999 – 2009?
The crux of the matter is – if U.S. stocks did not outperform historically, then nobody would want to overweight them. People like them now precisely because of their past performance, especially after a decade of tech-fueled large-cap growth.
International ETFs to consider
With that being said, the good news for investors considering international stocks is that there are a variety of low-cost, highly affordable ETFs out there.
A popular pick for investors desiring maximum simplicity and low fees are ETFs that combine developed and emerging markets. Great examples include the Vanguard Total International Stock Index Fund ETF (VXUS) and the iShares Core MSCI Total International Stock ETF (IXUS).
For investors wishing to exclude emerging markets (usually due to fears of geopolitical risk like with the collapse of Russian equity ETFs), there are ETFs that only track developed market equities. These include the Vanguard FTSE Developed Markets ETF (VEA) and the iShares Core MSCI EAFE ETF (IEFA).
For investors seeking higher returns in exchange for greater risk, overweighting emerging markets past their current 10%-ish global market cap weight is also a solution. ETFs to consider here include the Vanguard FTSE Emerging Markets ETF (VWO) and the iShares Core MSCI Emerging Markets ETF (IEMG).
Those looking to bet on a specific country's equity markets can find a variety of ETFs in iShares' lineup to utilize. Popular examples include the iShares MSCI China ETF (MCHI), the iShares MSCI Brazil ETF (EWZ), and the iShares India 50 ETF (INDY).
Finally, actively managed and factor-tilted international ETFs can give investors the potential to either outperform a benchmark or target different objectives, like higher dividend income. Examples of these ETFs include the WisdomTree Emerging Markets High Dividend Fund (DEM), and the WisdomTree Emerging Markets SmallCap Dividend Fund (DGS), which I previously analyzed in-depth in this article.
This content was originally published by our partners at ETF Central.