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How To Identify The Best International ETFs

Apr 30, 2009
Simon Maierhofer

Spring is here! Not only do we get to enjoy the beautiful array of spring colors, global stock markets are also blossoming. How can you identify the best in class international ETFs and are the global rallies true green shoots or just weeds?

Stocks, domestically and abroad, are blossoming once again. Since the March 9th low, the S&P 500 (NYSEArca: SPY) gained 30% while the broad based international iShares MSCI EAFE Index ETF (NYSEArca: EFA) spiked 33%. We’ll discuss in a moment whether these rallies are true green shoots or just weeds.

According to ETFguide’s ETF database, there are 13 broad international equity ETFs, 26 regional equity ETFs, 42 country-specific equity ETFs, 32 international equity sector ETFs and 16 size specific international equity ETFs. No doubt, finding the right ETFs is no walk in the park.

Broad international ETFs

The misconceptions exists that broad indexes like the MSCI EAFE deliver instant diversification across the developed world markets. Unfortunately, most broad international indexes lack proper diversification.

Japan and the UK alone account for 45% of the popular MSCI EAFE Index while Italy, Netherlands, Hong Kong, Finland, Singapore, Belgium, Denmark, Norway, Portugal, Austria, Greece, Ireland and Luxembourg control less than 14% of the index.

Even though the dominance of Japan and the UK is particularly pronounced in the MSCI EAFE Index, it is not isolated to the MSCI EAFE.

The SPDR S&P World ex-US ETF (NYSEArca: GWL) has a 21% allocation to Japan and 17% to United Kingdom stocks.  The SPDR MSCI ACWI ex-US ETF (NYSEArca: CWI) and iShares MSCI ACWI ETF (Nasdaq: ACWX) sport a 34% exposure to Japan and the UK.

The Vanguard FTSE All-World ex-US ETF (NYSEArca: VEU) distributes the weight among the top 5 countries more evenly. Japan has a 14% and the UK a 15% stake. In addition, Vanguard’s VEU holds 2167 stocks, thereby fully replicating the underlying index while the iShares MSCI EAFE ETF (NYSEArca: EFA) attempts to replicate the underlying index’s performance via a sampling approach. EFA holds 838 securities.

Is elevated exposure to Japan and United Kingdom a bad thing? That’s like asking if betting $1,000 on red is a bad thing. Fortunately, ascertaining the general direction of country specific equities is easier than predicting where the roulette ball will land.

Since the beginning of 2008, ETFguide has consistently cautioned investors to stay away from U.S. equities. A look at the chart reveals that Japan’s Nikkei 225 (NYSEArca: EWJ) and England’s FTSE 100 (NYSEArca: EWU) tends to move in sync with U.S. equities.

In addition to advocating short ETFs, on January 15th, ETFguide recommended the UltraShort MSCI EAFE ProShares (NYSEArca: EFU) and UltraShort MSCI Emerging Markets ProShares (NYSEArca: EEV). Both ETFs provide double leveraged short exposure to developed and emerging markets.

The larger trend for U.S. stocks is down. Does that mean that this current rally has been a surprise to ETFguide followers? Not at all. In the January issue of the ETF Profit Strategy Newsletter we predicted that the Dow Jones (NYSEArca: DIA) will bottom between 6,000 and 6,700 before staging the biggest rally since the October 2007 all-time highs.

If you own any of the above mentioned and other, broad international funds, the end stages of this rally should give you a chance to sell at respectable prices.

Pockets of strength

Even though the scope of volatility varies, with a few exceptions the global stock exchanges tend to move in sync. The challenge is to find true pockets of strength.

On December 11, 2008 we identified an opportunity in China’s SSE Composite. At the time, the SSE Composite was trading at around 2,000 and just broke out of a 12-month downward trend channel. We issued a target level of 2,700. Simultaneous to the U.S. market meltdown, the SSE Composite rallied to 2,500. ETFs tracking the Chinese market include the iShares FTSE/Xinhua 25 (NYSEArca: FXI) and iShares FTSE China 100 (Nasdaq: FCHI).

Since Northern Trust closed their suite of 16 country-specific ETFs, iShares has reasserted its monopoly on single country ETFs. 26 different iShares ETFs provide exposure to countries ranging from Israel to Chile.

Regional ETFs

When it comes to identifying regional profit opportunities, it would be best to stay away from “wet blankets” such as Japan and the United Kingdom. In fact, most of Europe is tangled up in the U.S. mortgage induced bear market which makes Europe a “non-opportunity.”

Most Asia ETFs lean on Japan as their top holdings. Once again, Japan and Europe will perform fine over the next several weeks/months, but if you are looking for an ETF with an expiration date beyond 2009, it would be best to stay away from Japan and Europe.

The iShares MSCI All Country Asia ex-Japan ETF (Nasdaq: AAXJ) connects investors to China, Taiwan, South Korea and Hong Kong. Taiwan and South Korea might be two countries able to bud the global down trend.

Is this rally doomed to fail? Sign up for the ETF Profit Strategy Newsletter and find out

The iShares MSCI Pacific ex-Japan ETF (NYSEArca: EPP) boasts a 65% allocation to Australia. This might not be such a bad thing as Australia’s ASX All Ordinaries just broke out of a 12-month downward trend channel, similar to China’s SSE Composite.

We’ve found that looking abroad for profit opportunities is often more cumbersome and less certain than exploiting the opportunities given by our domestic markets.

Much like ancient mariners were protected by faithful lighthouses, the ETF Profit Strategy Newsletter has not only kept investors safe from treacherous markets, it has consistently pointed to specific and easy to follow ETF profit strategies. The May issues includes target levels for this rally, the next leg down and the ultimate market bottom along with specific ETF recommendations for conservative, moderate and aggressive investors.

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