investing

An ETF to Own 6,000 Foreign Stocks

With foreign shares cheap and the dollar's strength possibly fading, markets outside the U.S. beckon.

Many people prefer the comforts of home when investing. That’s been a winning strategy lately, with Standard & Poor’s 500-stock index clocking the MSCI EAFE index, which tracks stocks in developed foreign markets, by an average of 10 percentage points per year over the past three years. But foreign stocks are cheaper than those in the U.S., and governments in Europe and other regions continue to promote easy-money policies even as the U.S. has begun to raise interest rates. These factors enhance the appeal of an exchange-traded fund such as Vanguard Total International Stock Index ETF (VXUS).

Packed with about 6,000 stocks, the ETF, a member of The Kiplinger ETF 20 tracks an index that holds everything from global giants, such as Nestlé and Daimler, to smaller firms, such as Canadian grocery chain Lob-laws and video-game maker Nintendo. Because it weights stocks by market value, the biggest companies dominate the fund; the median market value of its holdings is $22 billion. Overall, the fund recently had 83% of its assets in developed markets, led by Japan at 18%. Emerging markets rounded out the total, with 17% in countries such as China, India and South Korea.

Compared with the U.S. market, overseas bourses are cheap. Total International boasts a dividend yield of 2.9%, compared with 2.3% for the S&P 500. Moreover, foreign stocks in developed markets trade for less than 14 times estimated 2016 profits, compared with 16 for the S&P. Emerging markets sell for just 10 times earnings.

Granted, Americans face a big hurdle these days when they invest overseas: the mighty dollar. The greenback’s ascent over the past year and a half has made investments denominated in foreign currencies worth much less when converted to bucks. The MSCI EAFE index returned 5.8% in local-currency terms in 2015, according to J.P. Morgan. But for U.S.–based investors, the index dipped into the red because of the dollar’s gains. Emerging-markets stocks fared even worse, as commodity-producing nations suffered at the same time as their currencies slid against the dollar.

Although timing currency markets is notoriously difficult, some analysts see the greenback’s rally petering out. Slowing economic growth in the U.S. will eventually push down the dollar as investors look for better opportunities abroad, says David Kelly, chief global strategist for J.P. Morgan Funds. Rising U.S. interest rates (which should theoretically push up the dollar) may not spark much of a rally, either. The last three times the Federal Reserve embarked on a cycle of raising rates, the dollar fell in the six months after the first rate hike, says Kelly.

Leaving currencies aside, foreign stocks could get a lift from other forces. Profits of European companies haven’t recovered as much as those of U.S.-based firms, creating greater potential for expanding earnings to drive up stock prices.

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