Hey everyone and welcome back! So far, we’ve covered some of the tricks and traps involved in
diversifying your portfolio’s equity allocations across Canada and the U.S. That’s a great start,
but why limit yourself to North America? In this blog/video, we’ll head overseas,
to further diversify your portfolio by adding ETFs from other developed
markets around the globe. This time, we’ll zero in on three broad-market
ETF contenders, including: • The Vanguard FTSE Developed
All Cap ex North America Index ETF (VIU) • The iShares Core MSCI EAFE IMI Index
ETF (XEF), and • The iShares Core MSCI EAFE ETF (IEFA)
Once again, I’ve marked each fund’s icon with a small Canadian or U.S. insignia,
to indicate whether the ETF trades on Canadian or U.S. stock exchanges. As we’ve been discussing,
there are trading costs and tax ramifications to be aware of, depending on which exchange you tap.
Like our North American funds, all three of these international equity ETFs have been around for
many years, with IEFA launching first in 2012. XEF made its debut less than a year later,
with VIU appearing shortly afterwards. Next, there are the cost comparisons. Like the
U.S. equity ETFs from our earlier blog/video, the U.S.-listed IEFA has a noticeably lower
expense ratio than VIU or XEF, which trade on the Canadian stock exchanges. All else equal,
IEFA’s lower costs could help it track its index more closely than XEF or VIU can track theirs.
IEFA has also accumulated far more assets than either of our Canadian-listed funds.
Its relative scale might give IEFA a slight edge at more fully tracking its
underlying international equity index and thus better replicating its diversified holdings.
Speaking of indexes, VIU tracks the performance of the FTSE Developed All Cap ex North America Index,
while XEF and IEFA both track the performance of the MSCI EAFE IMI, or “Investable Market Index”.
Now, there’s a lot of new acronyms and terms included in these index names. Let’s
hit 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,
Australasia and the Far East”, which are the developed country regions this MSCI index tracks.
The terms “All Cap” and “Investable Market Index”, or “IMI”, are terms specific to
FTSE Russell and MSCI. They indicate these indexes track the performance of large-,
mid-, and small-cap companies. In other words, they are all “broad stock market indexes”.
These target indexes are also all weighted by market capitalization.
This means their large and mid-size company holdings explain most of each fund’s performance,
with small company stock returns contributing the remainder. And since these broad stock market
ETFs do not specifically target micro-cap companies, microcaps contribute little,
if anything to each fund’s end returns. Like the U.S., international stock markets have
less exposure than the Canadian stock market has to the financials, energy, and materials sectors.
This provides additional sector diversification for Canadian investors.
Besides helping us diversify across sectors, the international indexes these ETFs follow include
thousands of individual companies, providing additional diversification for global investors.
VIU’s FTSE index includes more companies than the MSCI index followed by XEF and IEFA.
Most of this difference can be explained by how each index classifies various countries’
markets as either “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 of Poland, but with much less impact, due to its smaller weight in the index.
This means that VIU (which follows a FTSE index) tracks hundreds of additional South
Korean and Polish companies, while the MSCI-tracking XEF and IEFA exclude them.
Even with their market classification differences, both indexes have experienced similar performance
since 2003. All else equal, we would expect the same moving forward over the long-term.
Besides offering important global diversification, these international equity
ETFs have each delivered positive long-term returns since their inception. However,
their long-term performance has included periods of gut-wrenching loss. For example,
during the early days of the COVID-19 pandemic, each of them lost nearly 30% of their value. None
of these ETFs existed during the Global Financial Crisis, but a comparable fund that did lost over
50% of its value in Canadian dollar terms at that time. That was the iShares MSCI EAFE ETF (EFA).
I’m not suggesting you try to time when to diversify in and out of international equity!
Long story short, you’re more likely to time it wrong than right, and miss out on the very
advantages you’re seeking to begin with. Instead, I’m telling you this, so you can prepare to endure
these types of losses when they occur, as they will from time to time. Just remember:
These periodic risks are essentially the entry price you pay, so you can be there to earn the
global market’s long-term expected rewards. In our next blog/video, we’ll show you how foreign
withholding taxes can also take a bite out of your international equity returns. See you soon!