International ETFs: Be Aware of Extreme Single Stock Exposure

What is one of the chief reasons for investing in exchange-traded funds? It's the ability to diversify away from the risk of a single company at a fraction of the expense levied by traditional mutual funds.

(Actually, pursuing greater diversification at a lower cost represents two reasons to love ETFs!)

Yet, many investors have focused solely on the returns that ETFs have served up, particularly in the emerging markets. It follows that few investors are paying enough attention to the risk of the individual country ETFs in their portfolios

For example, some international ETFs expose themselves to as much as 17%, 20%, even 25% in a single stock. And that's hardly the type of diversification one would expect when he/she invests in a particular country.

Country ETFs with excessive exposure to the stocks of individual companies include:

MSCI Mexico Index Fund (EWW) with 24.5% in America Movil SA de CV-Class L
MSCI Belgium Index Fund (EWK) with 24.5% in Fortis
MSCI South Korea Index Fund (EWY) with 17.8% in Samsung

Any investor would be mesmerized by the gains that these index funds have produced over the last 4 years. Yet a scandal at Samsung would seriously hamstring EWY. A hole in the hull at Fortis would sink the fortunes of EWK.

In contrast, regional ETFs (e.g., Latin America, Asia, Europe) have logged more impressive rewards relative to the risk one has taken; specifically, the returns of some of the more exotic country funds may only slightly outperform the broader region. And, in fact, many country funds have actually underperformed the regional counterparts.

Here are some potential, regional counterparts:

S&P Latin America Index Fund (ILF) with 11% in American Movil
S&P Europe 350 Index Fund (IEV) with 1% in Fortis
MSCI Emerging Markets Index Fund (EEM) with 4% in Samsung
MSCI PAcific ex-Japan Index (EPP) with 1% in Samsung

While I am hardly suggesting that one piles into European and Asian markets with reckless abandon, I am suggesting that investors carefully consider how much exposure might be appropriate to an individual stock.

For me, I tend to prefer ETFs with less than 10%-12% in a single company's stock. That would be a more reasonable scenario for a diversified basket... if you're into that "diversification" sort of thing.

Disclosure statement: Some of Pacific Park’s investment clients may hold positions in any of the investments mentioned above.

Comments

[Blair]

Gary's comments regarding the lack of stock diversification is correct -- to a given extent.

However, I cannot get excited about a position that amounts to just 1% of the portfolio -- iev and epp.

Even a 4% position is not excessive eem. The factor to watch out for is stock position liquity.

bzajac