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By Bob JohnsonThis article is the third in a series on popular Vanguard Stock ETFs. The previous two are:

Prior to that, back on August 6, 2013, I put forth an article titled, "Challenging A Dividend Growth Investing Myth With A Hybrid Portfolio Of Stocks And ETFs." It was my suggestion that there was a place in the investment world of many DG investors for both Dividend Growth stocks and ETFs. Indeed, there might even be cases where it made sense to own solely ETFs.

That heretical view, an anathema to some, kindled the fires of debate that left no doubt that the heat source was rising from the very depths of Hades, reserved for heretics condemned to perdition. The argument, individual stocks vs. ETFs, goes something like this. "My Maserati is better than your Dump Truck." The liturgical response being, "There is one truth." I suggest that some issues, such as how many stockbrokers can dance on the head of a pin, can never be resolved. From my perspective, further debate on that issue has little value. Know that your truth has made you whole. Go in peace.

Purpose

The purpose of this article is to present an analysis of the Vanguard FTSE Developed Markets ETF (NYSEARCA:VEA). My intent is that the reader will gain a good and complete understanding of the fund. We will look at what it is, where it fits in the Vanguard family of ETFs, its composition and performance as well as its suitability for investors. Where in your investment world might it fit?

Diversification Through ETFs

There is value in diversification.

We sometimes hear of a humble and quiet soul passing, who, much to the surprise of relatives and friends had accumulated $2 million worth of AT&T (NYSE:T) or Johnson & Johnson (NYSE:JNJ) stock. Those are good stories, and it warms our hearts to hear them. The case more often, however, is that people sink all of their savings into the stock of their employer, and then years later it is nearly worthless.

Diversification is primarily a risk management technique that assembles a wide variety of investments within a portfolio. The hope is that this will provide higher returns at lower risk than any individual asset in the portfolio. With assets that are not closely correlated, their differences smooth out the ups and downs of the portfolio. However, that is somewhat of a side benefit, as I do not believe that volatility caused by irrational fear or greed is a risk. It more often creates opportunities for good investors.

One of the ways we can diversity is to hold securities from different areas of the world and from different nations in these areas. Most investors have limited resources and may find it difficult in constructing a fully diversified international portfolio with individual stocks. The ETF we are looking at today is a fund that holds stocks from Developed Counties apart from the Americas. Fully 60% of the fund is invested in European countries; the remaining 40% is divided between Developed Asia, including Japan and South Korea, and Australia.

Vanguard Selected International Offerings

The below table lists the Vanguard ETFs we have looked at, VYM and VGK, along with the one we are looking at today, FTSE Developed Markets, VEA and two others for comparison. Additional alternatives are presented in the section of the article subtitled Alternatives.

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Where Does This Fund Fit

When we talk about diversification, in the sense of a portfolio core with satellites, we often assume a core of primarily blue chip US stocks. This core, however can have an emphasis. It might be designed with primarily large-cap type C (regular) corporations, such as stocks in the S&P 500 Index or in ETFs that replicate that Index, (NYSEARCA:SPY) and (NYSEARCA:VOO). It could have a value emphasis or an emphasis on growth. The core, consisting of either individual stocks or a fund, could be selected to have an emphasis on dividends. That is the case with the Vanguard High Dividend Yield ETF (NYSEARCA:VYM), which also falls into the Large-Cap Value category. It produces a yield about 100 basis points above the S&P 500 Index, such as the ETFs SPY and VOO. That is, it has a yield of about 3% instead of 2%.

Diversification into satellite holdings could include specialized companies organized as REITs, mREITs, MLPs or BDCs. Another form of diversification could be based on smaller market capitalizations, such as small caps or mid-cap sized stocks. Emphasis could also be added to sectors, and one could add dividend income with a utility ETF or a telecom ETF

Finally, an option is to diversify by geography, by companies from selected areas and countries. Some US investors may choose to hold only US investments. I believe that is a valid decision. There are advantages of remaining within one's home country, especially when that country is the US. First, there is no currency risk. You earn, save and spend US dollars, so why take a chance on weaker currencies? Second, the US is the world's largest stock market, encompassing over 45% of the world's total market cap. There is ample opportunity here, and many US companies receive a large part, often over half, of their revenues outside the US.

As the below chart from Forbes illustrates, while China may have a lot of people, Russia a lot of land and resources, those countries do not have a wealth of direct investment opportunities. The size of the investable opportunity in a country is not always closely correlated with GDP growth, natural resources or population. China and India have the most people, Rwanda's GDP is growing 4 times as fast as that of the US, Russia has vast land and resources, and none of those places offers very many investable opportunities. That is what is strategically wrong with the somewhat popular investing styles using emerging nations stocks and funds. If you want exposure to and revenue from most of the 180 countries in the world, three good ways to get it are by buying McDonald's (NYSE:MCD), Johnson & Johnson and Procter & Gamble (NYSE:PG).

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After the US, or perhaps the US combined with its much smaller neighbor to the north, the first logical place to invest is Developed Western Europe. If you include not only the prosperous Eurozone countries, but also the UK and Switzerland, you have added another 25% of the world market cap. That's easily done by buying Vanguard FTSE Europe ETF, VGK, and a link to an article on that fund is at the top of this article. After that, if you include the Developed Asian Nations, Japan, 7% of the world market cap, Australia, 3% and South Korea 2%, you have covered about 90% of the world's investment opportunities. Very little is to be gained by adding more countries.

Therefore, if one wants to go beyond the US, beyond Europe, with VGK, then Vanguard FTSE Developed Markets VEA is a logical choice. This is made up of European Developed Nations, 60%, and Asian Developed Nations, primarily Japan, South Korea and Australia, 40%.

Characteristics of VEA's Portfolio

Top Holdings

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Like the European fund, this fund has Nestle at the top and HSBC Holdings, Roche and Novartis right under it. However, in the case of this fund the top ten stocks comprise only 12.3% of the fund, rather than 19.5% as they do in VGK. The reason for that is, while VGK holds 496 stocks, this fund holds an awesome 1,298. Certainly, it not only adds diversification to your portfolio but it has diversification within.

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Vanguard, compared to its competitors, adheres very closely to its stated charter and marketing message. It has quite literally, 99% (see above) of its holdings where they are supposed to be, in developed nations. The mix stays at about 60% Europe and 40% Asia. It has a tilt toward value stocks and contains mostly large companies.

The current yield is 4.7%. Europe pays much higher dividends on average than US stocks, about twice as much.

Alternatives

You alone can best choose the kind of international diversification you want. Here are some additional choices.

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The Current Trends

I said in my recent article on VGK, the European fund, "The European economy emerged from its longest postwar contraction. Following six consecutive quarters of decline, the 17-nation group posted a quarterly growth increase of 0.3% for the second quarter." All global markets dipped significantly ending on June 24 of this year. The fastest increases since then are led by those in Europe, as the below chart shows. This illustrates the principal of thoughtful diversification in a graphic way. Since that date, VGK has increased 10% vs. the S&P 500's 5%. VEA is up 9.4%.

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Included below is a comparative 5-Year chart - the US has been strongly leading other markets since 2012. That trend may have changed.

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I Hold VEA, Should You?

I believe that asset allocation is the most important choice every investor must make. It is said that asset allocation decisions effect results a lot more than the choice of any securities. My overall allocation is Common Stocks, 84%; Bonds, 4% and cash 12%. I have a portfolio of about 35 individual stocks and 78% of the value is in US companies.

I intend to increase my foreign holdings from 22% to 30% of the total, and I will do that by averaging into VEA from my cash position. I prefer to make this allocation with one fund, rather than individual stocks or several funds. I have come to believe that when it comes to the number of securities one owns, less is more. I will continue to decrease my total number of holdings, and ETFs will be part of my strategy. Simplification of my portfolio and my life is the driving motivation.

I believe that VEA is an appropriate choice for others who want coverage outside the US, in the developed countries in Europe and Asia. I also believe this is an opportune time to make that investment as the short and intermediate terms look very good.

Conclusion

I welcome your comments and will try to answer any questions you have. I would especially like to hear about your asset allocation and your international diversification.

There is risk in all investments. Take care always. I wish you well.

Source: My Strategy For International Diversification