Minding the P's & Q's of International ETFs

International exchange-traded funds are all the rage.

Over the past year, about 40% of net cash flow into ETFs has gone into international products, according to Paul Mazzilli, director of ETF research at Morgan Stanley. In the third quarter alone, $2.1 billion of net new assets went into international ETFs, while domestic large-, mid- and small-cap ETFs all experienced net outflows, he reports.

"A lot of money has gone into international ETFs [largely because] it's the easiest simplest way [for U.S. investors] to get broad, diversified exposure," Mazzilli writes.

Strong performance has clearly played a part in investors' desire for overseas ETFs. The largest international ETF in terms of assets, the iShares MSCI EAFE Index (EFA), which tracks one of the best known benchmarks for non-U.S. stocks, is up almost 20% year to date and is one of several international ETFs to have outperformed the S&P 500 over the past one-, three- and five-year periods.

As with any area that's in vogue, ETF providers are taking notice and launching oodles of related products. As of Oct. 31, there were 81 international equity ETFs, up from 49 at the end of 2005, according to the Investment Company Institute. Assets in those ETFs have risen to $95.35 billion from $65.2 billion.

"The product developers aren't stupid, says Matthew Hougan, senior editor of the Journal of Indexing and Web site IndexUniverse.com. "There's been such huge asset growth in international ETFs over the last few years [and that's why] it's been a big area of focus" for new product offerings.

For example, WisdomTree Investments launched 10 international sector ETFs in October (adding to the 14 international products it already has trading). And the company recently filed for 21 new international products designed to track myriad international segments from dividend-paying Malaysian stocks to high-dividend yielding stocks in the U.K.

Meanwhile, State Street Global Advisors recently launched its first two international ETFs, both focused on Japan. The company has several more in filing that it plans to roll out over the next few months, including an international REIT ETF. PowerShares has a couple of international ETFs on the market and recently filed for 35 more.

This influx of new products is a good thing as it provides investors with more options and can lead to lower costs as competition heats up. But it also means that investors have to be careful about where they're putting their money, especially because investors are prone to chase performance.

International Powerhouse As overseas markets continue to outperform, money and ETF offerings have followed

"A lot of the reason that people became interested in international investing was that the international market was simply doing that much better than the U.S. market was," says Lipper senior research analyst Andrew Clark. However, a lot of the strong performance came from a weakening dollar, which hit a 20-month low vs. the euro on Monday.

But there's no guarantee the dollar's slide will continue, and investors with 50% or 60% international exposure should "consider paring that back somewhat, especially if you have exposure outside of the" European Union, says Clark, who believes about 25%-30% international exposure is appropriate for most investors.