Global Exposure Without Emerging Market Risk

FUND IN FOCUS: Global growth and monetary policy are diverging, with developed economies looking more attractive than emerging. One cheap ETF is positively skewed that way

Monika Dutt 29 October, 2015 | 10:00AM
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The global economic outlook is divided between improving developed economies and contracting emerging markets. Developed countries are recovering from the financial crisis of 2008, while slumping commodity prices and headwinds from China are continuing to steer emerging markets to the bottom of the performance table.

One of the cheapest funds on the European market offering global exposure

Global monetary policy is also diverging and long-term interest rates are widening. The Bank of England and the Federal Reserve are looking to increase rates, while the European Central Bank and the Bank of Japan have indicated a willingness to increase monetary stimulus to ward off deflationary pressure caused by declining commodity prices.

Oil prices have fallen by approximately 50% since mid-2014 due to lower demand – notably from China – and greater supply, causing a redistribution of wealth from oil-exporting countries like Brazil and Russia to oil importing economies like Europe and the United States. In this landscape of uncertainty, an argument can certainly be made for finding good value in the developed world.

Investors wishing to increase their exposure to advanced economies, while limiting their emerging market risk, can look to the iShares Core MSCI (IWDA) ETF. This fund spans 23 developed countries, but is heavily tilted towards the US stock market, representing approximately 60% of total portfolio allocation. By comparison, active funds offering global equity exposure allot only 39% on average to US stocks.

European equities make up approximately a quarter of iShares Core MSCI’s holdings. The remaining 15% is reserved for Greater Asia, markedly Japan, representing a significant 8%. IShares Core MSCI has no direct exposure to emerging markets, but the fund is not immune to spill over effects, prevalent in an increasingly connected economic and financial system.  

There is a simple rule to investing; high fees detract from long-term returns. Active funds offering global exposure charge a hefty price tag of around 2%. With 20 basis points, iShares Core MSCI is a one stop-shop core holding. The bottom line is: this fund is cheap.

Are Equities Expensive?

Market commentators are warning that US equities are overvalued, a reasonable concern for IWDA holders. Many investors are shunning their US exposure because of elevated valuations and the Fed’s anticipated rate hike. The recent trend has been to swap US holdings for undervalued European and Japanese equities. The S&P 500 has returned 1.9% year to date versus 13.6% and 11.9% for the Euro Stoxx and Topix, respectively.

America, home to some of the brainiest and most innovative companies in the world, remains a paragon of economic strength, even if equity valuations are looking high. Solid employment growth, housing improvement and healthy consumption means that exposure to the world’s largest economy shouldn’t be discarded.

Diversification: A Parable of Diverging Markets

This fund is well diversified by sector and security with financials accounting for 20.6% of the fund’s total allocation, followed by technology, consumer discretionary and healthcare with 13-14% each. Portfolio concentration is limited with the top 10 holdings accounting for less than 10% of the total index value.

Historically, the MSCI World Index has been less volatile than the MSCI Europe, Japan and Emerging Markets indices. For very little additional risk, relative to the MSCI USA, investors can increase their geographical diversification significantly with iShares Core MSCI.

Trends in European and US equity markets are similar, as these markets are highly correlated, but Japan provides the fund with some diversification benefits. Over the past twenty years, the MSCI Japan has had a correlation of 0.56 and 0.59 to the MSCI USA and the MSCI Europe indices respectively. During the same period, the MSCI USA and the MSCI Europe have moved more closely together, bearing a greater correlation coefficient of 0.85.

IShares Core MSCI is a popular product: it has £3.1 billion in assets under management. Since June of 2014, when iShares cut the fund’s fee from 40 basis points to 20 basis points, the ETF has seen a net inflow of around £2.2 billion. It is now one of the cheapest funds on the European market offering global exposure.

Given the current momentum, European equities may continue to generate excess returns for the fund. Exposure to the Japanese stock market will provide portfolio diversification, if historical patterns uphold. With emerging markets slowing due to falling commodity prices, minimising exposure to the developing world may not be a bad idea right now.

Investors should be weary of the ETF’s drawbacks though; it is strongly exposed to the US stock market, which may deflate once rates finally rise. Federal Reserve Chair Janet Yellen is dragging her feet, but with the Fed’s credibility on the line, she cannot debate and delay ad nauseam. There is one reassuring thought though: nothing will happen overnight. The world will still be here tomorrow.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
iShares Core MSCI World ETF USD Acc84.86 USD-2.27Rating

About Author

Monika Dutt  is a Passive Strategies Research Analyst for Morningstar Europe