CWI Has Solid Diversification In Every Way, If Investors Will Pay For It

| About: SPDR MSCI (CWI)
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Summary

I’m taking a look at CWI as a candidate for inclusion in my ETF portfolio.

The expense ratio is high for my taste, but the diversification is great.

The correlation to SPY is based on high trade volumes and a long sample period.

I’d be cautious about entering at a premium to NAV since I don’t expect those premiums to be maintained indefinitely.

I’m not assessing any tax impacts. Investors should check their own situation for tax exposure.

Investors should be seeking to improve their risk adjusted returns. I'm a big fan of using ETFs to achieve the risk adjusted returns relative to the portfolios that a normal investor can generate for themselves after trading costs. I'm working on building a new portfolio and I'm going to be analyzing several of the ETFs that I am considering for my personal portfolio. One of the funds that I'm considering is the SPDR MSCI ACWI ex-US ETF (NYSEARCA:CWI). I'll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level.

What does CWI do?

CWI attempts to track the total return (before fees and expenses) of the MSCI All Country World Index ex USA. At least 80% of the assets are invested in funds included in this index, or in ADRs representing the assets in the index. CWI falls under the category of "Foreign Large Blend".

Does CWI provide diversification benefits to a portfolio?

Each investor may hold a different portfolio, but I use (NYSEARCA:SPY) as the basis for my analysis. I believe SPY, or another large cap U.S. fund with similar properties, represents the reasonable first step for many investors designing an ETF portfolio. Therefore, I start my diversification analysis by seeing how it works with SPY.

I start with an ANOVA table:

The correlation is moderate at 86.6%. I'd like to see a lower correlation on my international investments, but this is still low enough to provide some diversification benefits. Extremely low levels of correlation are wonderful for establishing a more stable portfolio. I consider anything under 50% to be extremely low. However, for equity securities an extremely low correlation is frequently only found when there are substantial issues with trading volumes that may distort the statistics.

Standard deviation of daily returns (dividend adjusted, measured since January 2012)

The standard deviation is moderately high. For CWI it is .8916%. For SPY, it is 0.7300% for the same period. SPY usually beats other ETFs in this regard, so this isn't too absurdly high for another ETF. The combination of the high standard deviation and correlation being at 75% mean I probably won't consider this ETF for anything more than 5% to 10% of my ETF portfolio.

Liquidity looks fine

Average trading volume has been high enough that I'm not concerned. The average was around 300,000 shares per day.

Mixing it with SPY

I also run comparisons on the standard deviation of daily returns for the portfolio assuming that the portfolio is combined with the S&P 500. For research, I assume daily rebalancing because it dramatically simplifies the math. With a 50/50 weighting in a portfolio holding only SPY and CWI, the standard deviation of daily returns across the entire portfolio is 0.7835%.

With 80% in SPY and 20% in CWI, the standard deviation of the portfolio would have been .7438%.

If an investor wanted to use CWI as a supplement to their portfolio, the standard deviation across the portfolio with 95% in SPY and 5% in CWI would have been .7325%.

Why I use standard deviation of daily returns

I don't believe historical returns have predictive power for future returns, but I do believe historical values for standard deviations of returns relative to other ETFs have some predictive power on future risks and correlations.

Yield & Taxes

The distribution yield is 3.12%. The SEC yield is 2.22%. That appears to be a respectable yield. This ETF could be worth considering for retiring investors. I like to see strong yields for retiring portfolios because I don't want to touch the principal. By investing in ETFs I'm removing some of the human emotions, such as panic. Higher yields imply lower growth rates (without reinvestment) over the long term, but that is an acceptable trade off in my opinion.

I'm not a CPA or CFP, so I'm not assessing any tax impacts.

Expense Ratio

The ETF is posting .34% for an expense ratio. I want diversification, I want stability, and I don't want to pay for them. The expense ratio on this fund is higher than I want to pay for equity securities, but not high enough to make me eliminate it from consideration. It is pushing that way though. I view expense ratios as a very important part of the long term return picture.

Market to NAV

The ETF is at a 1.09% premium to NAV currently. Premiums or discounts to NAV can change very quickly so investors should check prior to putting in an order. I wouldn't want to pay this premium unless I could find a solid accounting justification for it. The ETF is large enough and liquid enough that I would expect the ETF to stay fairly close to NAV. Generally, I don't trust deviations from NAV and I will have a strong resistance to paying a premium to NAV to enter into a position.

Largest Holdings

The diversification is fairly solid in this ETF. My favorite thing about the ETF is easily the diversification. If I'm going to be stuck with that expense ratio, I expect it to buy a fairly strong level of diversification and in this case it appears to do just that.

Conclusion

I'm currently screening a large volume of ETFs for my own portfolio. The portfolio I'm building is through Schwab, so I'm able to trade CWI with no commissions. I have a strong preference for researching ETFs that are free to trade in my account, so most of my research will be on ETFs that fall under the "ETF OneSource" program.

I like the correlation and the diversification in the holdings, but the expense ratio is a bit high and I wouldn't want to enter into a position at a significant premium to NAV. In my opinion, 1% is a fairly significant premium to pay with no assurance that I could exit the position at the same premium. This looks like an ETF to keep on my list as an option for international exposure. If selected, I would wait for an entry price with a much smaller (or non-existent) premium to NAV.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.