What it means
Instead of buying individual foreign shares, which can be costly and complicated, an investor can buy one ETF that tracks a foreign market or region. The fund manager buys the underlying securities and the investor holds shares in the fund, which can be bought and sold during the trading day.
Prices are visible all day, unlike traditional mutual funds that are priced once daily. International ETFs come in several flavours.
Some track developed markets outside the home country, others focus on emerging markets, and some target a single country or sector, for example a fund covering only Japanese companies or only European banks. Their appeal in a portfolio is diversification.
Economies do not always move in step, so holding assets from several countries can smooth results, although in times of global stress many markets fall together. The benefit is therefore a smoother ride over long periods rather than protection in every downturn.
Costs and structure matter. Investors should look at the expense ratio (the annual fee taken from the fund), the spread between buying and selling prices, how closely the fund tracks its index, and whether it hedges currency risk.
Currency is the factor many new investors overlook. A foreign share can rise in its own market, yet deliver a lower return in the investor's home currency if that currency has strengthened in the meantime.
The nuance is that an ETF labelled international can still be concentrated. A fund may be dominated by a few large companies or a single country, so reading the top holdings and country weights is as important as reading the name.
In practice
Real-world examples.
Example
A retired teacher wants broad exposure beyond her home market. She buys an ETF tracking developed markets outside her country for her retirement account. One purchase gives her stakes in hundreds of foreign companies.
Example
A corporate treasurer invests part of the company's long-term reserve in an ETF of foreign government bonds with currency hedging. The hedge reduces swings caused by exchange rates. The treasurer accepts that hedging costs reduce the return slightly, because certainty about the dollar value matters more for reserves.
Example
A financial adviser builds a portfolio for a young client with a long time horizon. She includes an emerging markets ETF as a small slice of the total, because it carries higher risk and higher potential growth. She explains the extra volatility before the client agrees, and she shows him how the fund performed in past market falls.
Formula
Calculation
Return in home currency = (1 + Local market return) x (1 + Currency return) - 1
Suppose a US investor buys a Japan-focused ETF that is unhedged. The Japanese market rises 8% in local terms, but the yen weakens 5% against the dollar. The home-currency return is (1 + 0.08) x (1 - 0.05) - 1 = 1.08 x 0.95 - 1 = 1.026 - 1 = 0.026, or 2.6%. On a $10,000 investment, that is a gain of $260 rather than the $800 the local market return alone would suggest.Case study
Seen in the real world.
This is an illustrative story about a fictional investor, Maya, who put $20,000 into an ETF covering shares in several European countries. Over a year the underlying companies rose 10% in local currency, and Maya expected a gain of about $2,000.
During the same year, the euro weakened against the dollar by 6%. Because the fund did not hedge currency, her return in dollars was roughly 1.10 x 0.94 - 1 = 3.4%, or about $680.
Maya learned that a foreign investment has two sources of return, the asset and the currency. The fund's local-currency performance looked strong on its fact sheet, which hid the currency drag. The illustrative episode led her to compare hedged and unhedged versions of funds before investing further, and to read the fund fact sheet more carefully. She now checks the currency policy, the top ten holdings and the expense ratio before every purchase.
Watch out
Common mistakes.
- Assuming international means lower risk. Foreign investments bring currency, political and market risks in addition to the usual ones.
- Ignoring fees. Specialised international funds often charge higher expense ratios and have wider spreads than domestic ones.
- Buying a country fund and calling it diversified. A single-country ETF is concentrated and may move sharply with that country's economy.
Questions
People also ask.
Is an international ETF the same as a global ETF?
Not exactly. International usually means outside the home country, while global includes the home country as well, so the two funds can have very different weights.
Do international ETFs protect against currency swings?
Only if they are hedged. Unhedged funds pass the currency movement directly to the investor, for better or worse, and hedged funds charge for the protection.
How are they taxed?
Tax treatment depends on the investor's country and the fund's structure, including withholding taxes on foreign dividends, so professional advice is wise.
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