Advisors Pivoting to International Equities Have Choices

With core U.S. equity and fixed income ETFs posting modest gains of 2-3% YTD through mid-June, advisors are increasingly seeking diversification in international equities, with 50% expressing interest according to a VettaFi survey. This shift is driven by the strong performance of ETFs like IEFA and VEA, which have risen 19% YTD, fueled by robust macroeconomic conditions and attractive valuations outside the U.S.; however, ETFs vary in country-level exposure, as VEA includes Canada and South Korea, while others like IDOG and IQDG offer different approaches through dividend and sector weighting.

Analysis

Core U.S. equity and fixed income ETFs delivered modest 2%-3% year-to-date returns through mid-June, prompting a significant shift in advisor focus towards international equities for diversification, with 50% of VettaFi webcast respondents indicating this preference. This interest is largely fueled by the substantial outperformance of broad international developed market ETFs such as the iShares Core MSCI EAFE ETF (IEFA) and the Vanguard FTSE Developed Markets ETF (VEA), both up approximately 19% year-to-date through June 10, driven by robust macroeconomic conditions and attractive valuations outside the U.S. Despite similar overall performance, these market-cap weighted ETFs exhibit notable differences in country exposures; for instance, VEA includes Canada (10% of assets) and South Korea (4%), which are absent in IEFA due to differing underlying index methodologies. Investors also have options beyond market-cap weighting: the WisdomTree International Quality Dividend Growth Fund (IQDG) employs fundamental weighting with quality and growth screens, resulting in higher U.K. exposure (19%) and lower France exposure (6%) compared to IEFA. Conversely, the ALPS International Sector Dividend Dogs ETF (IDOG) focuses on high-dividend yields, equally weighting the five highest-yielding stocks per sector, leading to significant allocations in France (18%), Japan (13%), and Finland (10%), the latter being a minimal holding in IEFA. Actively managed ETFs like the Thornburg International Equity ETF (TXUE) and the MFS Active International ETF (MFSI) offer another avenue, with TXUE favoring France (22%) and MFSI incorporating a substantial emerging markets component (20%), including China, Taiwan, and South Korea, alongside developed markets like Japan (14%). The varying approaches highlight the necessity for investors to look beyond headline performance and understand the specific construction and exposures of international ETFs.

Key Decisions for Investors

• Investors should meticulously examine the specific country, sector, and methodological exposures of international ETFs, as demonstrated by the differing compositions of IEFA, VEA, IQDG, and IDOG, before making allocation decisions.
• Consider fundamentally weighted or dividend-focused international ETFs like IQDG or IDOG for potentially different risk-return profiles and factor exposures compared to traditional market-cap weighted alternatives, noting their distinct country concentrations such as IDOG's significant Finland allocation.
• For those seeking tailored international strategies or navigation through diverse market conditions, actively managed ETFs such as TXUE or MFSI could be explored, paying close attention to their specific investment theses, regional tilts, and particularly any emerging market allocations, as seen in MFSI.
• While the 19% YTD outperformance of international ETFs like IEFA and VEA is compelling, thorough due diligence on underlying index construction, fee structures, and the implications of varied country classifications (e.g., South Korea's status) remains crucial before increasing international exposure.