Global stock markets have shown a tighter correlation with U.S. stocks in the years following the credit crisis. However, the diversification benefits of overseas investing cannot be emphasized enough.
Emerging market investing has been written about frequently, but the need for other developed markets exposure is necessary for proper asset allocation. The iShares MSCI EAFE Index (EFA) has interesting benefits, proving a developed market strategy should not be ignored.
"Europe includes some of the largest developed markets outside North America. While nearly 65% of EFA's portfolio is held in European stocks, which may increase volatility in the near term, a recovery in Europe may offset weakness elsewhere. Japan represents the fund's second-largest market exposure. Overall, companies based in these regions generate a larger portion of their earnings and revenue from emerging markets than their counterparts in the U.S.," Alex Bryan wrote for Morningstar.
EFA has a high dose of U.S. and Canadian holdings along with mid-cap exposure to Asia, Europe and Australian developed markets. Various companies from the aforementioned regions do derive revenue from emerging markets, so ETF is also an indirect play on emerging economies at the same time, reports Bryan. This indirect exposure helped ETF prosper while recent growth in developed markets slowed.
EFA also adds other diversification benefits since it gives investors exposure to commodities. Commodity prices swings affect the profitability of companies in other industries which reduces the funds' volatility. Furthermore, the currency hedge that EFA provides is subtle, but was evident when the U.S. dollar weakened over the past 10 years. ETF gained an annualized 2.6%, reports Bryan. EFA also yields 3%, and costs 0.34%.
Morningstar gives this fund a favorable risk-reward profile for the long term.
The health of the economies in the eurozone, Japan and Australia all have an impact on EFA. The eurozone will be able to dodge a complete default due to the ECB's commitment to purchase unlimited debt from troubled countries, while the Japanese economy is looking more attractive due to current valuations in the equity market. Lastly, health of the Australian economy, which is influenced by the commodities cycle, looks to be favorable as China heads into a new phase of growth.
iShares MSCI EAFE Index