ETF Myths

With exchange traded funds, the average retail investor can branch out into overseas stock markets, but some have been reluctant to diversify on misconceptions related to investing with foreign ETFs.

Trang Ho for Investor’s Business Daily helps dispel five common myths on investing in foreign markets with ETFs.

  • High GDP Translates to High Performance. According to Vanguard, the correlation between GDP growth and stock market performance has been relatively zero. “This counterintuitive result holds across the major equity markets over the past 100 years, as well as across emerging and developed markets over the past several decades,” Vanguard said. Instead, Vanguard analyst point to the emerging market’s comparatively low equity valuations in the early 2000s and consistently higher-than-expected economic growth as catalysts for the emerging market’s outperformance.
  • Recessions Equals Underperformance. Emerging markets crashed in 2008 but none of them fell into recession. Moreover, many rebounded the following year while many developing countries fell into recession. The same phenomenon is also seen in the developed world – Italy’s economy shrank 2% in 2012 but the MSCI Italy Index returned 9%. The stock market runs ahead of the economy as it anticipates the economic turnarounds before they are established.
  • All Country ETFs are Interchangeable. When it comes to ETFs, every provider has a different methodology to selecting component holdings. Consequently, even though some ETFs may cover the same market, the different ETFs will offer varying exposure levels to a country’s sectors and different yearly performances.
  • All Country ETFs are Diversified. In some country ETFs, a specific sector will dominate the majority of holdings. For instance, Russia ETFs have a heavy weighting in the energy sector, whereas a majority of other emerging market ETFs lean toward financials.
  • Emerging Markets Means High Risk and Volatility. In comparing beta ratios – or the level of risk, stock markets of the world’s most violent regions have very low volatility, whereas very political stable countries had the most volatility. For instance, the Market Vectors Gulf States (NYSEArca: MES) has a beta of only 0.33, compared to the iShares MSCI Italy index (NYSEArca: EWI), with a 1.9 beta – a beta less than 1 means it is less volatile than the benchmark and a reading over 1 translates to higher volatility.

“You can’t trade country ETFs with a broad stroke,” Todd Rosenbluth, ETF analyst at S&P Capital IQ, said in the article. “You have to make sure you know what’s inside.”

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.