A Bat­tle of For­eign Stock Funds

In a se­quel to last month’s test, three for­eign mar­ket stock in­dex funds take on a sin­gle to­tal non-u.s. mar­ket in­dex fund. The re­sults are de­ci­sive.

Financial Planning - - CONTENT - By Craig L. Is­raelsen

Three for­eign mar­ket stock in­dex funds take on a sin­gle non-u.s. mar­ket in­dex fund. The re­sults are de­ci­sive.

WHAT IS TRUE OF IN­VEST­ING IN U.S. STOCKS IS ALSO true for in­ter­na­tional stocks: a group of three stock in­dex funds — each aimed at a sub­sec­tion of stocks — out­per­forms a sin­gle to­tal mar­ket in­dex fund.

We tested this ques­tion last month rel­a­tive to the en­tire United States eq­uity mar­ket, and the find­ings were clear: three Van­guard funds com­bined in equal weights and re­bal­anced an­nu­ally out­per­formed a sin­gle Van­guard U.S. stock mar­ket fund that at­tempts to cover the uni­verse of U.S. large­cap, mid-cap and small-cap stocks.

The 18-year an­nu­al­ized re­turn for the trio of funds was more than 200 ba­sis points higher than the sin­gle to­tal stock mar­ket fund. More­over, the trio had bet­ter three-year rolling per­for­mance 75% of the time.

But that is one just one to­tal stock mar­ket fund and just one as­set class — U.S. stocks. What if you looked at another to­tal mar­ket in­dex fund, one that seeks to repli­cate all non- U.S. stock mar­kets?


This month, we set out to de­ter­mine whether the three­a­gainst-one ap­proach is su­pe­rior when buy­ing for­eign stocks as well.

Once again. we turned to Van­guard to find the par­tic­i­pants for our con­test.

The firm has a one-stop of­fer­ing for in­vestors wish­ing to sim­plify their ex­po­sure to the non-u.s. eq­uity mar­ket, namely the Van­guard To­tal In­ter­na­tional Stock In­dex fund (VGTSX). It has an 80% al­lo­ca­tion to stocks from de­vel­oped for­eign economies, 15% to stocks from emerg­ing mar­kets, and the rest to cash and mis­cel­la­neous hold­ings.

This type of fund is cer­tainly con­ve­nient, but is it the best ap­proach?

Another ap­proach would be to buy sep­a­rate funds from three in­ter­na­tional mar­ket seg­ments: de­vel­oped for­eign large-cap value stocks, de­vel­oped for­eign mid-cap and small-cap stocks, and emerg­ing mar­ket stocks. For this com­par­i­son, the three in­di­vid­ual for­eign funds are Van­guard In­ter­na­tional Value (VTRIX), Van­guard In­ter­na­tional Ex­plorer (VINEX) and Van­guard Emerg­ing Mar­kets Stock In­dex (VEIEX).

When com­bined, th­ese three funds seek to ac­com­plish what VGTSX is at­tempt­ing to achieve. The time frame for this com­par­i­son is the 18 years from Jan. 1, 1999, to Dec. 31, 2016. Per­for­mance data came from the Steel Sys­tems Mu­tual Fund data­base.

The an­nual re­turns of th­ese four in­ter­na­tional funds are shown in the chart “Four Stal­warts.” Over the last 18 years, VINEX and VEIEX have in­di­vid­u­ally sig­nif­i­cantly out­per­formed VGTSX, by 562 ba­sis points and 438 ba­sis points, re­spec­tively. VTRIX also out­per­formed VGTSX, by a mod­est 79 ba­sis points.

Out­per­for­mance does come at a cost, how­ever. The stan­dard de­vi­a­tion of re­turns for VINEX and VEIEX were each roughly 43% higher than VGTSX. In study­ing the an­nual re­turns care­fully, it’s clear that much of that larger stan­dard de­vi­a­tion came from large pos­i­tive re­turns rather than un­usu­ally large neg­a­tive re­turns. The ex­cep­tions are the rel-

atively large losses for VEIEX in 2000, 2008 and 2015.

Also worth not­ing is the lower ex­pense ra­tio of VGTSX — less than half any of the other three funds. That is cer­tainly at­trac­tive. But it is im­por­tant to re­mem­ber that stated per­for­mance of any fund al­ready ac­counts for its ex­pense ra­tio.

Thus, the slightly lower ex­pense ra­tio of VGTSX pales in com­par­i­son to the per­for­mance ad­van­tage of the in­di­vid­ual in­ter­na­tional stock funds.

Con­ve­nience and keep­ing costs low are ob­vi­ously im­por­tant, but raw per­for­mance is ul­ti­mately more im­por­tant.

Let’s now ex­am­ine what hap­pens when we blend the re­sults of th­ese three in­di­vid­ual funds and stack them up against VGTSX.


We have two op­tions. The first is to in­vest in the three nar­rower funds in the same al­lo­ca­tions that VGTSX uses (which is 80% to de­vel­oped for­eign mar­kets and 20% to emerg­ing mar­kets).

To do this, VTRIX will have a 40% al­lo­ca­tion, VINEX a 40% al­lo­ca­tion, and VEIEX a 20% al­lo­ca­tion. Each fund is then re­bal­anced an­nu­ally to keep the al­lo­ca­tions in line.

The sec­ond op­tion in blend­ing re­sults is to sim­ply in­vest equally in each fund, namely three al­lo­ca­tions of 33.33%. The

The best way to build a port­fo­lio: op­ti­mize ex­po­sure to the as­set classes you are seek­ing to cover, and then keep the cost as low as pos­si­ble.

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