International ETFs: Risky Shores?

International ETFs are the obvious complement to US large cap or total market ETFs in a balanced portfolio. International contains large cap companies in developed economies and helps round out exposure to the global economy. In practice this means Europe and Japan, but right now they are growing slowly and have currencies under siege.A handful of solid, well-priced ETFs give broad exposure to mostly large or mid-cap stocks in economies outside the US. The most popular is iShares MSCI EAFE ETF (NYSEArca:EFA - News), which tracks the popular MSCI Europe Australasia Far East Index (EAFE) of advanced economies. Most other broad international funds include small amounts of emerging markets. SPDR MSCI ACWI ex-US ETF (NYSEArca:CWI - News) and iShares MSCI ACWI ex US ETF (NasdaqGM:ACWX - News) both track about 45 countries in the Morgan Stanley All Country World Index. SPDR S&P World ex-US ETF (NYSEArca:GWL - News) and Vanguard FTSE All-World ex-US ETF (AMEX:VEU - News) round out the group with similarly comprehensive coverage. Most cost about 0.15% more than similar US ETFs, so even in a flat world there is a slight premium to going abroad.International ETFs have trailed the US notably in the first half of 2010 reflecting not so much confidence in the US rather than concern for Europe and Japan:

Seeking better returns elsewhere makes sense when economic prospects abroad appear better than in the US, valuations of foreign stocks are cheaper than in the US, and the dollar seems likely to depreciate. None of these seem to be obviously true in 2010.European and Japanese growth forecasts have weakened considerably in early 2010. This was triggered by the disintegration of Greek bonds and the realization that Spain and Ireland could follow. Japan has very high debt levels and is still a prisoner of its export economy which suffers when foreign consumers pull back. Yes, China and India are racing ahead, but they are represented lightly if at all in international ETFs.The Yen and the Euro have softened, and many economists forecast continued weakness for the Euro in particular. If so, it will further lower international ETF returns for US investors.Historically international exposure has helped to lower overall portfolio volatility, but increased correlation has dampened this effect in the past decade. It is fashionable to say that international correlation is unprecendented, but there have been many periods of increasing and decreasing correlation going back more than a century (Goetzmann, Li, and Rouwenhorst). Correlation increased during periods of economic integration, which today we call globalization, so the current trend is typical. Unfortunately, recent correlation has been strong just when the investor least desired it, during stock market plunges.There are many other ETFs for playing international stocks in various ways. The following ETFs make it easy to filter for company size and growth/value characteristics:

• iShares MSCI EAFE Growth ETF (NYSEArca:EFG - News), annual fees: 0.4%
• iShares MSCI EAFE Small Cap ETF (NYSEArca:SCZ - News), annual fees: 0.4%
• iShares MSCI EAFE Value ETF (NYSEArca:EFV - News), annual fees: 0.4%
• SPDR Dow Jones Global Titans ETF (NYSEArca:DGT - News), annual fees: 0.5%
• iShares S&P Global 100 ETF (NYSEArca:IOO - News), annual fees: 0.4%
• PowerShares BLDRS Developed Markets 100 ADR ETF (NasdaqGM:ADRD - News), annual fees: 0.3%
• Vanguard FTSE All-World ex-US Small-Cap ETF (NYSEArca:VSS - News), annual fees: 0.38%

A number of funds select and filter international stocks based on proprietary formulas using fundamental financial ratios:

• PowerShares FTSE RAFI Developed Markets ex-US Small-Mid Portfolio ETF (AMEX:PDN - News), annual fees: 0.75%
• WisdomTree DEFA ETF (NYSEArca:DWM - News), annual fees: 0.48%
• WisdomTree International LargeCap Dividend ETF (NYSEArca:DOL - News), annual fees: 0.48%
• WisdomTree International MidCap Dividend ETF (NYSEArca:DIM - News), annual fees: 0.58%
• WisdomTree International SmallCap Dividend ETF (NYSEArca:DLS - News), annual fees: 0.58%
• WisdomTree International Technology Sector ETF (NYSEArca:DBT - News), annual fees: 0.58%

The following leveraged funds are strictly for short-term speculative trading:

• ProShares Short MSCI EAFE ETF (AMEX:EFZ - News), annual fees: 0.95%
• ProShares Ultra MSCI EAFE ETF (NYSEArca:EFO - News), annual fees: 0.95%
• ProShares UltraShort MSCI EAFE ETF (AMEX:EFU - News), annual fees: 0.95%

Co-founder of indexfunds.com, author of two books on investing, and founder of ETFzone.com, Will has been writing on indexing issues for 8 years. He holds an MBA from the University of Texas at Austin.