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When Not to Be Stylish Going Abroad

Two new style-based ETFs -- one value, one growth -- aren't the best way to access foreign markets.

In the past couple of years, as foreign investing has become more popular, the investment community has obliged that demand with many new products. As with new products in any field, there are bound to be failures, and investments are no exception. I want to point out a pair of new ETFs that offers investors little advantage.

Last summer, in an effort to blend foreign exposure and preferred investing style -- growth or value -- in one product, iShares came out with two exchange-traded funds that split the EAFE (Europe, Australasia, Far East) index into growth and value funds:

iShares MSCI EAFE Growth Fund

(EFG) - Get Free Report


iShares MSCI EAFE Value Fund

(EFV) - Get Free Report

. These funds divide EAFE in a similar manner to the way iShares has split the

S&P 500

and Russell indices.

I don't believe using style-based ETFs to access foreign markets is a great way to go. That's something investors already may have figured out: Both funds have seen only anemic volume. Among the issues I see: flaws in the weightings given to the component countries, trouble evaluating the prospects of so many different countries for value or growth -- and most important (or damning): simpler, cheaper and more effective alternatives.

Unusual Attributes

While country makeup is virtually identical in the growth and value ETFs, the sector allocations have some differences and some similarities, and the biggest difference is in the financial sector. The value fund has 41% weighting in the financial sector, compared with finance's 15% weighting in the growth fund. The two funds have similar weightings in consumer discretionary, industrials, energy and telecom.

Because both funds are so new, the dividend information may not be complete, but ETFconnect has both funds yielding roughly 0.5%. In comparison, the

iShares MSCI EAFE Index Fund

(EFA) - Get Free Report

yields 1.79%.

One particularly strange quirk of the funds is that the value fund has a higher beta, at 0.86, than the growth fund, at 0.83. Typically, growth is thought to be more volatile.

Structural Flaws

The structure of both ETFs is currently set so that two big components could offset each other: Both have close to 25% each in Japan and the U.K.

The problem I see with these weightings is that, often, the Nikkei and the FTSE 100 tend to criss-cross in opposite directions.

Because both economies have very similar weighting in each of the funds, they may offset each other, resulting in the fund not being able to capture the desired effect from either.

Because both funds have only been trading for six months, it may be too early to know definitively that this will be an issue, but it bears watching.

In addition to similar weightings for Japan and the U.K., the two funds also have similar weights in France, at roughly 9%; Germany, at 6.5%; Switzerland, which is 7%; and Australia, at 5%. Again, this could result in offsets that cancel out the beneficial effects of all these different exposures.

Tangled Economic Cycles

I believe that in trying to tilt a portfolio toward growth or value, an investor needs to be able to do some forward-looking analysis. An important determinant in whether to favor growth or value with an investment can be the current state of the economy you are investing in. Based on precedent, growth tends to do well later in the economic cycle.

A fund that blends together many different countries, which presumably are all at different points in the economic cycle, makes this task much more difficult. And as I've pointed out above, EFG and EFV are invested all over the globe.

Opposite Effects
The movements of the Nikkei and FTSE 100 could offset each other

Source: Yahoo! Finance

Easier Alternatives

An investor seeking simple, broad-based foreign exposure would be better off holding just one fund, perhaps

iShares MSCI EAFE Index Fund

(EFA) - Get Free Report

, and paying one commission than trying to blend EFG and EFV into some sort of EFA-beating combination. An investor who wants to isolate narrower themes for foreign equities may want to look to single-country funds and common stocks instead.

These new ETFs are bold attempts to capture a trend, but again, investors are better served elsewhere.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider iShares MSCI EAFE Growth Fund and iShares MSCI EAFE Value Fund to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. At the time of publication, Nusbaum had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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