Moving Beyond EAFE

By Matthew Hougan

The drumbeat calling the MSCI EAFE Index obsolete just got louder.

EAFE (pronounced "eee-fah") has been the benchmark for international investments for the past 30 years. EAFE stands for Europe, Australasia and the Far East, and the MSCI EAFE Index holds essentially all large- and mid-cap stocks located in developed markets outside of the U.S. and Canada. Fund managers operating abroad have been comparing their performance to the MSCI EAFE Index for decades.

In our globalized age, however, there's a growing feeling that EAFE is insufficient. Steven Schoenfeld, chief investment strategist for Northern Trust's Global quantitative management group, has been leading the charge. He called EAFE obsolete at the 2007 Art of Indexing conference, and then repeated that charge in a detailed paper in May 2008.

The reason is simple: EAFE excludes three important categories of international investments—Canada, emerging markets and international small-cap stocks.

The sexiest part of that argument is emerging markets. Anyone who watched the China Olympics knows that emerging markets are rapidly ... well ... emerging, and that they play an increasingly important part in the global economy. Investors who stick with EAFE as their sole benchmark for international investments are ignoring markets like China and missing an important part of the global investment opportunity set.

That argument is picked up today in this Wall Street Journal "Fund Track" article, which notes that emerging markets account for 30% of global gross domestic product—and could make up 35% of global GDP by 2013.

According to the Journal, "since the beginning of the year, some of the nation's largest pension plans have told their stock-fund managers to ditch EAFE in favor of the MSCI All Country World Index, which has about 12% exposure to emerging-market stocks, as well as the U.S. and Canada."

If you ask me, it's a change whose time has come.