Going global: Regional or international funds?
If an investor had put $10,000 into the iShares MSCI Pacific ex Japan ETF in early November 2001, right after inception, that position would have been worth over $48,000 in late August of this year, assuming dividend reinvestment. A $10,000 investment in iShares Europe ETF at the same time would have grown to less than $24,000.
If picking a fast-growing region can deliver that much outperformance, should investors opt for a regional fund rather than an international fund where sluggish European stocks might be mixed with surging Pacific companies?
“We’re not using regional funds now,” says Albert Brenner, director of asset allocation strategy at Bridgeport, Connecticut-based People’s United Bank. “The role of international equities in a portfolio is to mitigate overall risk as well as to provide the opportunity for superior returns. It can be very challenging to understand the specific risks involved with various regional funds.”
Some advisors share this skepticism about regional funds. “We recommend that clients cover developed markets with one or two positions to gain broad exposure, primarily to Europe and Asia,” says Peter Mallouk, president of Creative Planning, a wealth management firm in Leawood, Kan. “For those clients who should consider emerging markets exposure, we recommend one or two positions to diversify across the key areas such as Latin America, Brazil, China and India. We view rotating from country to country or region to region as a game that an investor is likely to lose so we prefer to maintain very diversified positions in this space.”
Mallouk’s references to “one or two positions” does not mean, say, one Asian fund and one Latin American fund for an emerging markets allocation. “I much prefer one emerging markets position to cover all the regions or countries,” he says. “The stock markets of these countries are very small. Owning, say, Indonesia, Egypt, Mexico and China is like owning just a few mega-cap U.S. companies. One emerging markets position gets investors into the game with their very long run money. They get into a volatile asset class that will likely reward them over the long run. Rotating among countries or regions is like buying and selling stocks all the time – such a strategy will increase taxes and fees, probably leading to underperformance.”
The same principle holds for developed foreign markets, according to Mallouk. “I prefer to use a single large position for this allocation (an ETF can work) but I understand that some clients prefer to utilize two international funds,” he says.
Brenner says that he has used regional funds in the past. “I was an advisor with a smaller firm,” he recalls. “It seemed to make sense to have a separate allocation for Japan, for example, and for the United Kingdom and for the Eurozone, rather than lumping them together in one developed markets fund. Therefore, the firm used separate ETFs for each of those areas. However, I realized that it was difficult to know enough about each region to make asset allocation calls.”
At his present firm, Brenner uses actively-managed international funds for foreign exposure, relying upon managers who have shown good results in balancing holdings from multiple regions. “We’re considering regional funds,” he says, “and we might use some in the future.” The key is to be confident of having the resources to make reasonable decisions as to how much of clients’ portfolios to devote to a given region.
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.