In the investing world, the last decade has seen U.S. stocks — particularly mega-cap tech companies — outperform their international counterparts by a considerable margin.
This domestic dominance has led many investors to lean heavily into U.S. equities, called a “home-country bias,” but such a strategy could also be a classic example of recency bias. This occurs when investors extrapolate recent events into the future, essentially assuming that because something has performed well in the near past, it will continue to do so indefinitely.
While American giants like Apple Inc. (ticker: AAPL), Amazon.com Inc. (AMZN), Nvidia Corp. (NVDA) and Microsoft Corp. (MSFT) have been delivering eye-popping returns that have so far continued into 2023, it’s essential to remember that what’s in favor today may not be tomorrow.
Case in point: Consider the “Lost Decade” of 1999-2009, during which the total U.S. stock market eked out an annualized return of just 1.7%. Meanwhile, international developed markets fared significantly better, returning an annualized 4.1%, and emerging markets soared with an impressive 13.7% annualized return.
“The ex-U.S. market makes up about 40% to 45% of the world’s market capitalization, so by ignoring international stocks, investors are missing out on roughly half the world’s investing opportunities,” says Kirk Kinder, founder and president of Picket Fence Financial. “Moreover, international stocks are substantially undervalued when you look at metrics like price-to-earnings and price-to-book ratios.”
The main takeaways are that the top-performing stocks do indeed rotate, and markets around the world go through cycles of outperformance and underperformance. By diversifying internationally, investors can potentially smooth out their long-term returns and avoid deep, prolonged drawdowns.
“Adding international stocks to your portfolio can dampen volatility and improve returns, since the U.S. economy and market may face challenges at different times compared to international regions,” says Scott Klimo, chief investment officer at Saturna Capital. “Mitigating currency risk also plays a role as the U.S. dollar may strengthen or weaken versus other countries at different times.”
|Fund||Top Holdings||Top Exposure||Expense Ratio|
|Vanguard Total International Stock ETF (VXUS)||Taiwan Semiconductor Manufacturing Co. Ltd. (TSM), Nestle S.A. (NESN.SW)||Europe, Pacific, emerging markets||0.07%|
|Vanguard Total International Stock Index Fund Admiral Shares (VTIAX)||Taiwan Semiconductor, Nestle||Europe, Pacific, emerging markets||0.11%|
|Fidelity International Index Fund (FSPSX)||Nestle, ASML Holding N.V. (ASML)||Europe, Pacific, Asia Pacific ex-Japan||0.04%|
|Fidelity Emerging Markets Index Fund (FPADX)||Taiwan Semiconductor, Tencent Holdings Ltd. (OTC: TCEHY)||Emerging Asia, Latin America, Middle East||0.08%|
|iShares MSCI BIC ETF (BKF)||Tencent Holdings, Alibaba Group Holding Ltd. (BABA)||China, India, Brazil||0.69%|
|iShares MSCI South Africa ETF (EZA)||Naspers Ltd. (NPN.JO), FirstRand Ltd. (FSR.JO)||South Africa||0.58%|
|iShares International Dividend Growth ETF (IGRO)||Novartis A.G. (NVS), Nestle||Japan, Canada, Switzerland, U.K.||0.15%|
Vanguard Total International Stock ETF (VXUS)
“Vanguard’s recently released 2023 Economic and Market Outlook expects international equities to outperform U.S. stocks over the next decade, largely driven by lower valuations, higher dividend yields and a favorable currency outlook,” says Christine Franquin, principal and senior portfolio manager at Vanguard. For a low-cost international ETF, Vanguard offers VXUS at a 0.07% expense ratio.
By tracking the FTSE Global All Cap ex US Index, VXUS provides diversified exposure to over 7,900 stocks from non-U.S. markets. Currently, developed markets like Japan, the U.K., Canada, France, Germany and Australia account for around 75% of the ETF, while emerging markets like China, India, Brazil and South Africa account for the other 25%.
Vanguard Total International Stock Index Fund Admiral Shares (VTIAX)
While VXUS provides broad international exposure in an ETF format, some investors may prefer its mutual fund counterpart, VTIAX. Essentially serving as the Admiral Shares equivalent of VXUS, VTIAX has certain features that could make it more appealing for certain types of investors, while still charging a reasonable expense ratio of 0.11%, albeit with a $3,000 minimum required investment.
For instance, mutual funds like VTIAX allow for automatic investments and the reinvestment of dividends, which can simplify long-term investing. Unlike ETFs, which require purchasing whole shares or fractional shares, mutual funds like VTIAX enable investors to invest in any amount. Finally, trading is also less complex as, unlike ETFs, mutual funds are only priced once a day after the market closes.
Fidelity International Index Fund (FSPSX)
Investors wishing to focus on international markets with a longer history, more mature economies and stronger regulatory systems may prefer a developed markets fund like FSPSX. This mutual fund tracks the Morgan Stanley Capital International Europe, Australasia, Far East Index, which holds stocks from countries like Japan, the U.K., France, Switzerland, Germany and Australia, to name a few.
Notable stocks held by FSPSX that U.S. investors may be familiar with include Toyota Motor Corp. (TM), Nintendo Co. Ltd. (NTDOY), Nestle and ASML Holding N.V. The fund has been in operation since 1997, and has attracted over $43 billion in assets under management, or AUM, largely due to its low expense ratio of 0.035% and lack of a minimum required investment.
Fidelity Emerging Markets Index Fund (FPADX)
The counterpart of FSPSX is FPADX, which has an emerging market focus. These markets are characterized by their developing infrastructure, nascent-but-growing financial systems and increasing consumer demand. While developed markets like those in Europe are known for stability and mature industries, emerging markets offer the potential for higher returns, albeit with greater volatility.
FPADX serves as an excellent counterpart to FSPSX, offering investors exposure to these fast-growing economies. The fund tracks the MSCI Emerging Markets Index, which includes stocks from countries like Taiwan, China, India, South Korea, Brazil and South Africa. Compared to FSPSX, FPADX charges a slightly higher expense ratio of 0.075%, but it still has no minimum required investment.
iShares MSCI BIC ETF (BKF)
For investors looking for a nuanced approach to international investing, the commonly used division between developed and emerging markets may not be enough. Another angle to consider is the concept of the BRICS — an acronym that stands for Brazil, Russia, India, China, and South Africa. This informal international coalition has become especially prominent in recent years.
For exposure to three of the biggest BRICS countries, investors can buy BKF, which tracks the MSCI BIC Index. This ETF holds 633 market-cap-weighted Chinese, Indian and Brazilian equities for a 0.69% expense ratio, which allows investors to gain targeted exposure without having to convert currency and buy individual stocks or use American depositary receipts and global depositary receipts.
iShares MSCI South Africa ETF (EZA)
Investors considering BKF for BRICS exposure should note its limitations, most notably the absence of Russia and South Africa from the fund. Sanctions were imposed on the former following its invasion of Ukraine, leading to liquidity issues in its stock market and ultimately causing ETFs focused on Russia, like the iShares MSCI Russia ETF (ERUS), to be liquidated in August 2022.
However, investors can still round out a BRICS investment by combining BKF with EZA. This ETF tracks the MSCI South Africa 25/50 Index and offers exposure to 37 large- and mid-cap South African equities across various sectors, with concentrations in financials, materials and consumer discretionary stocks. Currently, EZA charges a 0.58% expense ratio.
iShares International Dividend Growth ETF (IGRO)
ETFs like IGRO offer a way to put dividend investing strategies in play with an international focus, paying a decent 30-day SEC yield of 2.8% while only charging a 0.15% expense ratio. This ETF tracks the Morningstar Global ex-US Dividend Growth Index, which implements a strict set of screeners to select its portfolio of around 390 holdings from both developed and emerging markets.
To be eligible, stocks must hail from the broader Morningstar Global Markets ex-U.S. Index, not be a real estate investment trust, or REIT; possess five consecutive years of dividend growth; not rank in the top 10% in terms of 12-month dividend yield; and have a payout ratio of less than 75%. These screeners are designed to ensure both the quality and sustainability of dividend payments.
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Update 08/28/23: This story was previously published at an earlier date and has been updated with new information.