For investing internationally, single-country and regional ETFs are practical tools for achieving very specific exposure. Nearly every developed and emerging-market country has at least one ETF tracking it, and there are regionally focused ETFs offering exposure to equities in Latin America, North America, and Asia, amongst others. In this article, we will highlight some of the issues specific to investing in ETFs tracking international equities.
Timing the Market
ETFs that track securities listed on overseas exchanges tend to trade at greater premiums and discounts to their net asset values (NAVs), as these funds’ NAV is usually a static value as most international markets are closed during some or most of normal UK trading hours. Generally, investors should attempt to trade an ETF when the trading hours of the ETF and its underlying holdings overlap in order to ensure the most accurate pricing possible. For instance, UK investors looking to trade an ETF tracking the S&P 500 should ideally wait until the afternoon when US markets open and the index’s constituent shares are being feverishly bought and sold in New York.
That said, when the markets on which an ETFs underlying constituents are closed, the ETF is serving as a price discovery vehicle. That is to say ETF premiums/discounts to NAV can be leading indicators of the price of the underlying. For example, early morning trading of a London-listed ETF tracking the S&P 500 will incorporate news and economic data that’s surfaced since the prior day’s market close in New York and can serve as a predictor of where the index will open at the start of the new trading day.
Assessing Premiums and Discounts
A good measure to determine the appropriateness of an ETF premium or discount at times when the fund’s underlying securities aren’t being actively traded is the ETF’s bid-offer spread. Typically, a narrower spread indicates that the market is showing general agreement on the true value of the ETF and its underlying securities. A tight bid-offer spread is probably a better indicator that an ETF is trading in-line with the value of its portfolio, as opposed to comparing an ETF's price with its static NAV--which reflects the prior closing prices on a now dormant market.
Know What You Own
Also, investors interested in international ETFs should--as always--examine the fund’s holdings--or the relevant index constituents in the case of a swap-based fund. Some of these funds can have large weightings in certain sectors or companies, which could make the ETF riskier than a more broadly diversified fund. For example, iShares MSCI Brazil ETF (IDBZ) has a 42% weighting in materials and energy companies, which includes Vale (~12% of the total portfolio) and Petrobras (~18%). Global demand for commodity products, and Chinese demand in particular, will be a more significant growth driver for these firms than domestic consumption. As such, this fund is not only a play on Brazil but is also an indirect play on commodity prices and thereby the strength of the Chinese economy.
Currency Considerations
Investors in international ETFs should also consider the effects of fluctuations in foreign exchange rates and how that may affect their investment. For example, from February 2010 to June 2011, the strengthening Australian dollar versus the Pound provided a significant boost to the iShares MSCI Australia ETF's (SAUS) returns. Over this time period, the iShares Australia ETF returned 26.6%, far outpacing the return of the MSCI Australia Index in Australian dollar terms, which was 6.1%. But keep in mind, this type of strong currency lift will be hard to repeat, and is even more difficult to predict.
Lee Davidson and Patricia Oey are both ETF analysts with Morningstar.
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