When looking to overseas markets, people have to consider the various risks associated with each sector and country. Alternatively, investors can look to a broad exchange traded fund strategy that focuses on high quality international names with sustainable advantages.
On the recent webcast, ETF Strategy to Access Morningstar’s Top International Picks, Dan Lefkovitz, Content Strategist for Indexes Morningstar, pointed out that investment returns across various foreign countries has been uneven as various macroeconomic and geopolitical forces may weigh on returns.
For example, in the 2011 to 2015 period, emerging markets have returned a minus 3.8%, whereas U.S. markets returned 12.3%.
Nevertheless, when crafting a diversified investment portfolio, investors should not completely write off foreign exposure. If an investor allocates his or her portfolio by global market capitalization, the U.S. stock market makes up 53.1% of the global market-cap, along with 16.2% Europe ex-United Kingdom, 10.9% Asia ex-Japan, 8.1% Japan, 6.7% U.K., 2.8% Canada and 1.1% Latin America. Investors would also miss potential opportunities from a number of large international brands.
On a survey of advisors attending the webcast, 36.8% of respondents said they are thinking of increasing their international equity exposure in the second half of 2016, followed by 35.6% who will keep positions as is.
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Due to the diverse nature of the international markets, active management has been more successful in generating alpha, or outperformance, in the international category, according to Morningstar data. The majority of advisors on the webcast also share this view point, with 61.0% of respondents using mutual funds as a means to access international equities, followed by 30.2% in ETFs.
Alternatively, investors can follow a customized index-based strategy that implements actively managed styles in a passive investment wrapper to potentially generate alpha with international exposure.
[related_stories]Specifically, Alex Morozov, Director of European Equity Research at Morningstar, pointed out that Morningstar’s team of analysts has applied one consistent methodology across their global coverage universe. The Morningstar’s so-called Economic Moat Indexing methodology has focused on five sources of economic moats, including intangible assets, switching costs, network effect, cost advantage and efficient scale as a means of implementing type of actively managed selection process within an index.
Intangible assets include brand recognition to charge premium prices. Switching costs make it too expensive to stop using a company’s products. Network effect occurs when the value of a company’s service increases as more use the service. A cost advantage helps companies undercut competitors on pricing while earning similar margins. Lastly, efficient scale refers to a competitive advantage in a niche market.
Related: Find Value with Wide Moat ETFs
Consequently, due to these various advantages, the investments in economic moats may help diminish portfolio risks.
“A wide moat company is positioned to sustain economic profits for at least 20 years, a narrow moat company, 10,” Morozov said.
Brandon Rakszawski, Product Manager for VanEck, pointed out that investors interested in the international economic moat strategy can utilize the VanEck Vectors Morningstar International Moat ETF (NYSEArca: MOTI), which tracks the Morningstar Global ex-US Moat Focus Index. The underlying index includes about 50 quality international names, targeting the most attractively priced companies and those with a wide economic moat.
Additionally, for U.S. markets, investors can also look to the popular he Market Vectors Morningstar Wide Moat ETF (NYSEArca: MOAT).
“The Morningstar Wide Moat Focus Index has historically outperformed the broad U.S. equity markets and active managers as represented by Morningstar large blend category average of open-end mutual funds,” Rakszawski said.
Financial advisors who are interested in learning more about Morningstar’s international investment strategy can watch the webcast here on demand.