If you’ve only invested in U.S. equities in the past two decades, you’ve likely won big, at least compared to non-U.S. stocks. Narrow that down to two years, and you may have wished you’ve listened to your advisor recommending you diversify into international stocks, because ETFs like the iShares Core MSCI EAFE ETF (BATS:IEFA) have done very well. IEFA in particular hasn’t delivered explosive gains, but it has kept up with the S&P 500 in the past year. Doing that during a tech rally while holding 2,600 international stocks is impressive.
It’s worth looking into these stocks because they can help you kill two birds with one stone. Most portfolios are now holding too many mega-cap tech stocks, and it’s only going to get worse in the coming months due to SpaceX’s IPO going euphoric. By the time Anthropic and OpenAI come in, probably half your portfolio is going to be betting on AI.
International stocks seem far more sensible.
IEFA gives you the good kind of “international”
The iShares Core MSCI EAFE ETF is not going to hand you stocks from fragile economies or countries prone to sudden instability. It invests exclusively in developed markets in Europe, Australasia, and the Far East (which is what “EAFE” stands for). This includes countries like Japan, the United Kingdom, France, Germany, and Australia. It explicitly excludes the U.S., Canada, and emerging markets.
Very interestingly, IEFA has an expense ratio at just 0.07% against the SPY’s 0.09% despite juggling so many international stocks. You get a 3.38% dividend yield on top of that, far better than the sub-1% yield that the S&P 500 offers.
IEFA’s top holding gets a 2.9% weight, with the second-largest holding at just 1.25%. On the other hand, the S&P 500 has Nvidia (NASDAQ:NVDA | NVDA Price Prediction) at 7.8%. Has that been a good thing in the past? Yes. However, the top-heavy structure will be a massive drag when the music stops.
Can international stocks keep outperforming?
The dollar has depreciated by over 15% from 2022 highs, but has been trading essentially sideways in the past year. Major banks expect the dollar to slide further, especially if the Iran ceasefire translates into rate cuts down the line. You don’t need dollar depreciation to outperform using international stocks.
The biggest advantage international stocks have now is that they are not as frothy. You are paying 17x earnings, whereas the SPY is trading at over 27x earnings. The Korean market proved that international stocks can re-rate suddenly when all the pieces line up. A boom in memory stocks spilled over into the rest of Korea’s stock market, with the KOSPI index up 195%. I’m not saying you’re going to see the German or the French markets surge like that, but the valuation gap between U.S. stocks and international stocks gives them more room to rally.
International stocks are expected to continue outperforming U.S. ones for years if institutions are correct that we’re going through a cyclical valuation reversion and a currency cycle. These cycles last for about 7 years on average.
Buy, hold, or sell the IEFA ETF?
You’re casting a wide net over thousands of stocks in developed markets. This is only worth it if you are looking to diversify extensively and you’re confident that the international markets will keep outperforming the U.S. one.
Most investors should not go all-in on the IEFA. You should instead be more selective with international stocks. The Avantis International Small Cap Value ETF (NYSEARCA:AVDV) for small caps, and the Avantis International Equity ETF (NYSEARCA:AVDE) are good options. If you want to stick to major issuers, you can buy the iShares International Select Dividend ETF (BATS:IDV) or the Franklin International Low Volatility High Dividend Index (BATS:LVHI). All of them have performed very well.
I’d tag IEFA a “Hold” for most investors. Having thousands of holdings is not conducive to market-beating returns.
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