iShares International ETF Gets Competition

The iShares MSCI EAFE Index Fund(EFA) gives investors cheap and easy access to foreign stocks, but not market-cap risk.

The exchange-traded fund, one of the most popular, is dominated by mega-cap stocks including BP(BP), HSBC(HBC) and Nestle(NSRGY).

About a year ago, State Street(STT) launched the SPDR S&P International Mid Cap ETF(MDD). It's the mid-cap cousin of the iShares fund, and it's been on a tear recently.

Though there are many similarities between the two funds, there are notable differences. SPDR S&P International Mid Cap is heaviest in Japan, at 32%, and the U.K., at 15%. For the iShares MSCI EAFE Index Fund, the proportions are 24% and 20%, respectively. From there, each fund has mid-single digit weightings in smaller European countries. The mid-cap fund has 7% of its assets in Canada, and the large-cap fund has none.

Each fund has about 20% in financials. The SPDR S&P International Mid Cap Fund allocates 23% to industrials versus 11% for iShares MSCI EAFE. SPDR S&P International Mid Cap is also heavier in consumer discretionary and technology.

As for individual stocks, SPDR S&P International Mid Cap owns Sanyo Electric(SANYY), Thomson Reuters(TRI) and Randgold Resources(GOLD). Worth learning about are Tobu Railway(TBURF), a commuter-train service in Japan, and Marine Harvest(MNHVF), one of several publicly traded Norwegian fisheries.

Even if ETFs aren't your preferred investment vehicle, looking under the hood is a good source for stock ideas. The composition of the fund leads me to think it will outperform its mega-cap rival in an economic recovery and a new bull market. Smaller stocks tend to lead off during the bottom of the cycle until mega caps take over. SPDR S&P International Mid Cap's smaller orientation, combined with the sectors it favors, has allowed it to outperform the iShares MSCI EAFE Index Fund by better than 10 percentage points in the past three months.

The SPDR S&P International Mid Cap ETF isn't without its drawbacks. Being a broad-based fund, it forces you to own some countries that may have bigger problems than the U.S. Those include Japan, the United Kingdom and Switzerland. There is also no choice with regard to sector exposure. (You may not want to own a fund that has 20% invested in financial stocks.) There has been, and will continue to be, more specialization with new ETFs that will allow for narrower investment selection without having to take single-stock risk. Of course, those funds will have their own drawbacks. SPDR S&P International Mid Cap has a lot of potential utility, but you should know the drawbacks before you buy it.

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