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.
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?
BUYING FOREIGN STOCKS
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.