By Michael Johnston
As the ETF universe has expanded dramatically over the last several years, many investors have taken advantage of this asset class to tap into international equity markets. With single-country ETFs dedicated to dozens of developed and emerging markets, accessing the major--and not-so-major--stock markets around the globe has never been easier.
When evaluating international equity ETFs, as with all ETFs, it is important to take a look under the hood and fully understand what the portfolio includes. Below, we highlight a few relatively common characteristics of international stock ETFs that might be somewhat disconcerting to investors.
1. Major Sector Biases
Many international equity ETFs feature some big tilts towards certain sectors of the economy, giving heavy weightings to certain types of companies while overlooking others altogether. That can result in concentrated risk for investors, especially when ETFs highlight sectors such as energy that can be impacted by often volatile commodity prices.
The iShares MSCI Taiwan Index Fund (EWT) has about half of its holdings in tech stocks, reflecting the tech-centric nature of the Taiwanese economy at present. But in most international equity ETFs, it is energy, financials, and materials that get the biggest allocations in the sector breakdown. The reason for that tilt is that banks, energy companies and mining firms are often the largest companies in an economy, meaning that they receive the biggest weighting in cap-weighted benchmarks.
Consider some popular international equity ETFs with big tilts towards these corners of the market:
iShares FTSE China 25 Index Fund (FXI) comprises 15% in energy and 52.9% in financials.
MSCI Malaysia Index Fund (EWM) comprises 0.0% in energy and 28.8% in financials
MSCI Canada Index Fund (EWC) comprises 26.3% in energy and 27.8% in financials.
These big concentrations are not inherently a flaw in these products. It is important to keep in mind that in many cases they simply reflect the composition of the underlying economy [see Global Titans ETFdb Portfolio]. Canada is home to big banks and big oil firms. Many of the largest companies in China are financial institutions. But it is certainly worth noting when analyzing potential opportunities.
2. Single Stock Concentrations
Concentration in international equity ETFs is not only an issue from a sector perspective; many products targeting stock markets outside the U.S. have hefty weightings to a single company: