Flows data confirm that advisors and investors were partial to international equity-traded funds last year. Six of 2015's top 10 asset-gathering ETFs were international equity funds, while just two the Vanguard 500 Index Fund (VOO) and the Vanguard Total Stock Market ETF (VTI) were U.S. equity funds.
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Still, more than half of the world's combined equity market capitalization is found in the United States, a factor that contributes to home country investors. Then there is volatility. Foreign equities, even some hailing from developed markets, have a tendency to be more volatile than their U.S. counterparts.
There could also be good reasons for U.S. investors to overweight U.S. stocks. For example, U.S. stocks should serve as a better long-term hedge against U.S. inflation than foreign stocks. Currency fluctuations can also make foreign stocks more volatile, as a strengthening U.S. dollar detracts from their returns. During the past decade, currency fluctuations accounted for nearly a quarter of the total volatility of the foreign developed-markets stocks in the MSCI EAFE Index. Consequently, foreign stocks can be tougher to own, according to a recent Morningstar note.
The iShares MSCI Emerging Markets Minimum Volatility ETF (iShares Inc. (EEMV)) has become popular with investors if for no other reason than that trimming volatility with developing world stocks results in an ETF that has been less bad than traditional emerging markets funds.
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Low volatility in emerging markets usually means large weights to Malaysia, South Korea and Taiwan. Those countries combine for almost 38 percent of EEMV's weight. EEMV has a developed market equivalent in the form of the $4.3 billion iShares MSCI EAFE Minimum Volatility ETF (EFAV).
EFAV attempts to construct a low-volatility portfolio by selecting stocks from the MSCI EAFE Index. To do this, it uses a constrained optimization approach that takes into account individual stock volatilities as well as the correlations among them. The constraints limit the size of individual positions and the fund's sector and country tilts relative to the MSCI EAFE Index. EEMV follows a similar approach in emerging markets, according to Morningstar.
EFAV allocates nearly 53 percent of its combined weight to Japan and the UK. The ETF has a beta of 0.68 and a standard deviation of nearly 10.4 percent, according to iShares data.
EFAV is up 3 percent over the past year, while the MSCI EAFE Index is down 5.3 percent. In November, iShares introduced a currency hedged answer to EFAV, the iShares Currency Hedged MSCI EAFE Minimum Volatility (BATS: HEFV), along with five other currency-hedged minimum volatility ETFs.
So far, EFAV has accomplished what it set out to do. Since its inception in 2011, this fund exhibited nearly a quarter less volatility than the MSCI EAFE Index. In fact, its volatility was comparable to VTI's, despite its unhedged currency exposure. EEMV exhibited a similar reduction in volatility relative to its parent benchmark, though not surprisingly, it was still more volatile than VTI, said Morningstar.
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