When it comes to adding international securities to a portfolio, most investors look for basic regional exposure, such as buying a European or an emerging market exchange-traded fund, but single-country ETFs can offer targeted investment opportunities.
As the name implies, single-country ETFs invest in a nation. Investors can use these ETFs to amplify existing international exposure for either a tactical or strategic position in a portfolio’s asset allocation, ETF market participants say.
Investors who are interested in these ETFs should know that they often contain fewer underlying securities than regional ETFs, and like all international ETFs, currency fluctuations can play a part in returns.
[See: 9 International ETFs That Are Off the Beaten Path.]
Global exposure. More investors may want to add international securities to their portfolios, given the upswing in the global economy. After a few years of underperformance, most international ETFs are outperforming domestic benchmarks.
This outperformance is seen in top regional ETFs, such as iShares Core MSCI Emerging Markets ETF ( IEMG), up 32.2 percent year-to-date, and Vanguard FTSE Europe ETF ( VGK), up 24.72 percent, two of the largest regional ETFs by assets under management. Comparatively, the SDPR S&P 500 ETF ( SPY) is up 14 percent for the same period.
JJ Feldman, portfolio manager at Los Angeles-based Miracle Mile Advisors, says his firm has used single-country ETFs to enhance international exposure in client portfolios. Although Miracle Mile currently is not using any single-country ETFs, Feldman explains how the firm used one in the past. To boost its exposure to India, Miracle Mile bought the Columbia India Consumer ETF ( INCO) to add to the core emerging market ETF the firm uses, the iShares Core MSCI Emerging Market.
Because the regional ETF only has a 9 percent weighting to India, adding a small amount of the Indian consumer ETF increased the portfolio’s allocation to the country’s economy, he says. The Indian ETF also had different holdings from the core emerging market ETF, so no investments overlapped. INCO is up 35.9 percent this year.
[See: 10 ETFs to Buy for Aggressive Growth.]
Regional ETFs may contain many holdings, and depending on how the ETF is constructed, it could have a heavier weighting to one country, which is common with market capitalization-weighted ETFs, Feldman says. That means smaller countries with outsize performance could be overshadowed.
For example, in Vanguard’s FTSE Europe ETF, the United Kingdom is the top country represented, at 28 percent of the ETF, with France in second at 15 percent. The Netherlands is at 5 percent. An investor who thinks Dutch companies may do better in the global economy could use the iShares MSCI Netherlands ETF ( EWN) to increase exposure. That ETF is up 32.4 percent year-to-date, vastly outperforming the broader regional Vanguard ETF. Comparatively, iShares MSCI United Kingdom ETF ( EWU) is up 16 percent over the same period.
Tactical opportunities. Jonathan Molchan, portfolio manager at New York-based Horizons ETFs Management (US), says another way to use single-country ETFs is to capitalize on trends that you believe will favor, say, the global economy or an asset class. ETFs that invest primarily in countries like the U.K., Germany and Japan can be barometers for the global economy in general, he says, while some emerging market countries like Brazil can be tactical plays on commodities.
Political events can sometimes lead to tactical opportunities. Feldman says that after the U.S. election the Mexican peso fell sharply based on expectations it would be hurt if the U.S. renegotiated the North American Free Trade Agreement. But the peso and Mexican stocks rebounded, with the iShares MSCI Mexico Capped ETF ( EWW), currently up 19.5 percent this year.
Investors who thought the sell-off was overdone had an opportunity to buy the ETF cheaper earlier this year, he says. “That’s how you can use it,” Feldman says. “You can say I like these companies, this country” regardless of headlines.
Currency and concentration risk. Tushar Yadava, iShares investment strategist at BlackRock in New York, says a key consideration for investors interested in international ETFs is currency, noting that buyers are taking on both equity risk and foreign-exchange risk. A strong U.S. dollar can be a drag on returns, which is what happened in 2014, Yadava says. “People looked at their portfolios and were like, ‘hang on a minute, Europe’s done quite well if I look at that in local terms … but if I pulled up my European ETF it was looking absolutely dour,'” he says.
Also, Yadava says investors should understand the fund’s construction and the benchmark the ETF follows, making sure it accurately represents the country, its economic product and the publicly listed companies. “What am I trying to accomplish when I’m buying a far-off destination” is a question investors should ask, he says.
Many single-country ETFs can cost more than regional ETFs. While the previously mentioned iShares core emerging market fund costs 14 basis points, Columbia India Consumer ETF costs 89 basis points. Developed market, single-country ETFs are also pricier compared with their regional counterparts. The iShares Netherlands and United Kingdom ETFs each are 48 basis points, but the Vanguard FTSE Europe ETF is 10 basis points.
[See: 7 Investment Fees You Might Not Realize You’re Paying.]
Concentration risk is another concern. Regional ETFs may have hundreds or thousands of holdings, whereas single-country ETFs may have fewer than 100. That can make them more volatile. “You are shrinking the number of holdings considerably and forfeiting that diversification, but if you have a very bullish outlook on a specific country, you can benefit from that return,” Molchan says.
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How to Use Single-Country ETFs originally appeared on usnews.com
