Foreign Developed Market ETFs For Your Core ETF Portfolio

| About: iShares Core (IEFA)

Summary

I recently reviewed the Seeking Alpha ETF Investing Guide and decided to implement it for a portion of my portfolio.

This article reviews the iShares Core MSCI EAFE ETF, the fourth ETF in the core portfolio of Seeking Alpha’s ETF Investing Guide.

IEFA is a good ETF for the foreign developed market portion of most investor’s Core ETF portfolio. The Vanguard FTSE Developed Markets ETF is another good option to consider.

The Seeking Alpha ETF Investing Guide

I recently reviewed the Seeking Alpha Investing Guide and decided to allocate part of my portfolio to a core portfolio of ETFs, similar to that suggested by the guide. I do not intend to completely switch course from my current allocation but to set up a separate core portfolio of ETFs and to allocate a majority of my investments to this Core ETF portfolio over time.

After reviewing the investing guide, I drafted a procedure for implementing the suggestions of the guide. Currently I am reviewing each of the suggested ETFs to determine which to buy. This article focuses on the foreign developed market portion of the Core ETF portfolio and the iShares Core MSCI EAFE ETF (NYSEARCA:IEFA).

iShares Core MSCI EAFE ETF - Investment Synopsis

The iShares Core MSCI EAFE ETF seeks to track the investment results of an index composed of large, mid and small-capitalization developed market equities, excluding the U.S. and Canada. IEFA provides exposure to a broad range of companies in Europe, Australia, Asia, and the Far East, holding 2,526 stocks as of December 31, 2015. IEFA provides low cost, comprehensive access to stocks in developed foreign countries. IEFA can be used in the core of your portfolio to diversify internationally and seek long-term growth.

Long term performance of foreign developed markets compared to the S&P 500

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Source: Yahoo Finance (2/4/2016)

As the chart above shows, since July 2001, the iShares MSCI EAFE ETF (EFA) (the blue line, up 31%) has underperformed U.S. large-cap stocks (represented by the S&P 500, the red line, up 84%). EFA was iShares first offering of a foreign developed market ETF and has more history than the newer offering IEFA. EFA is a little different than IEFA in that it tracks an index of foreign developed markets that does not include small-cap stocks.

5 Year performance of IEFA and EFA compared to the S&P 500

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More recently, over the last 5 year period, IEFA (the blue line, up 6%), has again significantly underperformed the S&P 500 (up 35%). Also interesting is the difference in the performance between EFA (iShares first foreign developed market offering with a higher expense ratio and that does not include small-cap stocks, the green line, up just 2%) and IEFA (iShares latest foreign developed market offering with a lower expense ratio and which includes small cap stocks, the blue line, up 6%).

When setting up a Core ETF portfolio and making an initial allocation, an investor may want to consider both the relative historical performance and the expected future performance of foreign developed markets versus the other sectors covered in the Core ETF portfolio.

Equity characteristics of IEFA vs the S&P 500

iShares Core MSCI EAFE ETF

iShares Core S&P 500 ETF (NYSEARCA:IVV)

Price/Earnings Ratio

16.54

18.84

Price/Book Ratio

1.66

2.76

Beta vs S&P 500

0.99

1.0

Dividend yield

2.68%

2.05%

Click to enlarge

Source: iShares by BlackRock (as of 12/31/2015)

After under-performing the S&P 500 for some time, the price/earnings and price/book ratios for IEFA are lower than that of iShares S&P 500 ETF and the dividend yield is higher. The price/earnings and price/book ratios will have fallen somewhat since they were calculated by iShares on December 31, 2015.

Top 10 holdings

Source: iShares by BlackRock (as of 2/2/2016)

IEFA's top ten holdings are large well known foreign companies that make up approximately 10.5% of total holdings. Because the MSCI EAFE Investable Market Index uses a market-cap weighting structure, the larger companies have a larger weighting, which some investors may consider a drawback.

Country Breakdown

Source: iShares by BlackRock (as of 2/2/2016)

IEFA is most heavily invested in Japanese companies, followed by a number of European countries. These markets have not performed as well as the U.S. market recently which has caused IEFA to underperform the U.S. market.

Equity sector diversification

IEFA's largest stock holdings are in the financial sector. Investors setting up a core portfolio of ETFs will probably want to reduce their holdings of individual stocks, particularly in sectors where both the ETF and the investor are heavily invested.

ETFs in the foreign developed market category

Symbol

Fund Name

AUM ($MM)

Expense Ratio

EFA

iShares MSCI EAFE ETF

56,329M

0.33%

VEA

Vanguard FTSE Developed Markets ETF

28,007M

0.09%

DBEF

Deutsche X-trackers MSCI EAFE Hedged Equity ETF

12,705M

0.35%

IEFA

iShares Core MSCI EAFE ETF

9,635M

0.12%

EFAV

iShares MSCI EAFE Minimum Volatility ETF

4,666M

0.20%

HEFA

iShares Currency Hedged MSCI EAFE ETF

3,609M

0.36%

EFV

iShares MSCI EAFE Value ETF

2,604M

0.40%

EFG

iShares MSCI EAFE Growth ETF

2,383M

0.40%

EWC

iShares MSCI Canada ETF

1,642M

0.48%

FNDF

Schwab Fundamental International Large Company ETF

815M

0.32%

Click to enlarge

Source: Seeking Alpha (as of 2/2/2016)

Above is a list of the top 10 foreign developed market ETFs, listed by assets under management (AUM). As the table shows, IEFA is the fourth largest foreign developed market ETF by AUM. For those that want to do further research, additional detail on these ETFs is available on Seeking Alpha's ETF Hub.

Expenses and dividend yield

IEFA's expense ratio is 0.12%, this is well below the average expense ratio of similar funds. Of the top ten US foreign developed market ETFs listed above, only VEA has a lower expense ratio.

VEA tracks the FTSE Developed All Cap ex U.S. Transition Index. The FTSE Developed All Cap ex U.S. Transition Index is an interim index that will gradually increase exposure to small-capitalization stocks and Canadian equities while proportionately reducing exposure to other stocks based on their weightings in the FTSE Developed All Cap ex U.S. Index. VEA can be used to rotate the foreign developed market portion of your portfolio into, when tax loss selling.

IEFA's 30 day SEC yield was 2.68.%, as of December 31, 2015.

Conclusion

I believe IEFA is a good ETF for the foreign developed market portion of an investor's Core ETF portfolio. I believe VEA is a good alternative and may be used to rotate into, for the foreign developed market portion of an investor's core portfolio, when tax loss selling. After reviewing the other ETFs in the core ETF portfolio, I expect to allocate a portion of my portfolio, currently allocated to individual stocks, to either increasing my position in VEA or to IEFA.

Addendum

Seeking Alpha's Investment Guide Core ETF Portfolio

ETF Ticker

Fund Name

Fund Description

Expense Ratio

VOO

Vanguard S&P 500 ETF

Large cap US stocks

0.05%

IJH

iShares Core S&P Mid Cap ETF

Mid cap US stocks

0.12%

VTWO

Vanguard Russell 2000 ETF

Small cap US stocks

0.15%

IEFA

iShares Core MSCI EAFE ETF

Multi cap foreign developed market stocks

0.12%

IEMG

iShares Core MSCI Emerging Markets ETF

Multi cap emerging market stocks

0.18%

LQD

iShares iBoxx $ Investment Grade Corporate Bond ETF

US investment grade corporate bonds

0.15%

PLW

PowerShares 1-30 Laddered Treasury Portfolio ETF

US Treasuries

0.25%

SCHP

Schwab U.S. TIPS ETF

US TIPS

0.07%

VNQ

Vanguard REIT Index ETF

US REITs

0.10%

DBC

PowerShares DB Commodity Index Tracking ETF

Broad commodities

0.85%

Click to enlarge

Simply Investing - Philosophy

Establishing a core portfolio in well-diversified, low expense ETFs, held for the long term, is a good idea for most all investors. The core of a small portfolio can start off as simple as one well diversified global ETF with a low expense ratio, like the Vanguard Total World Stock ETF (NYSEARCA:VT). Typically, as the portfolio grows, the core of the portfolio would include exposure to the ten asset classes listed above.

There are four steps needed to set up an efficient investment plan. The decisions and actions required to set up the plan and purchase the ETFs can be done in about 4 hours (see the further reading section below for more details):

  1. Decide on an asset allocation plan among the ETFs in the core portfolio
  2. Open an online brokerage account with a linked online bank account
  3. Determine if you will invest all your investment funds at once or over a period of time
  4. Determine which investments to buy in your taxable and tax deferred accounts

The core ETF portfolio outlined above, after tax, should significantly outperform either individual stock picking or a portfolio managed by a financial advisor. Over the typical investors time horizon of 40+ years the expected advantage of this core ETF portfolio is staggering.

Investors that enjoy the investment analysis process and are willing to spend the time to analyze and invest in individual stocks or sectors can still do this. I believe, the majority of these investors should still set up a core ETF portfolio, but can allocate a small, fixed percentage of their portfolio to "edge" positions, which offer additional risk and opportunity.

Further reading

ETF Investing Guide - Written by Seeking Alpha's Founder in 2006 is a great guide for setting up a portfolio of ETFs.

Set Up A Core ETF Portfolio Now - Describes the four steps required to implement the suggestions in the ETF Investing Guide. The ETF Investing Guide is made up of 54 articles and takes some time to read and assimilate the information. This article condenses the information from the guide down to four steps that can be completed to set up a core ETF portfolio in around four hours.

VOO the first ETF in the core ETF portfolio is reviewed here, The First ETF You Should Buy.

IJH the second ETF in the core ETF portfolio is reviewed here, IJH: The Second ETF You Should Buy.

VTWO the third ETF in the core ETF portfolio is reviewed here, The Third ETF You Should Buy.

This article reviewed IEFA the fourth ETF in the core ETF portfolio.

Future articles will review the rest of the ETFs in the core ETF portfolio.

Disclosure: I am/we are long VT, VEA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.