CAPE: A New Approach To Foreign Equity ETFs

ETF Database

When it comes to portfolio allocation strategies, foreign investments are certainly one of the main go-tos as investors look to various corners of the market for more meaningful and stable returns. Adding exposure to equities from around the globe not only provides great diversification benefits, it also has the to potential to produce uncorrelated returns that may be more appealing than domestic investments. But with a wide array of options, sorting through the space can seem like a rather daunting task [see Free Report: How To Pick The Right ETF Every Time].

Enter the Shiller cyclically adjusted 10-year price-to-earnings ratio: CAPE. Adam Butler, Michael Phillbrick and Rodrigo Gordillo of Darwin Funds in collaboration with Mebane Faber of Cambria Quantitative Research recently published a research paper on how they applied the CAPE ratio to over 40 countries.

In its simplest form, the CAPE methodology smooths out earnings over 10 years and

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Foreign Investments Using CAPE
then adjusts for inflation, smoothing out peaks and valleys that normally happen over the course of a full business cycle. As a result, the researchers found a way to gain exposure to countries based on valuation, instead of pure market-cap weighting [see 3 Things You Need To Know When Picking A Country ETF].

ETF Options For Countries With Low CAPE Ratios

In a recent interview with ETF Database, Mebane Faber discussed some of the countries he thinks are poised to exhibit strong returns in the next five to ten years based on their CAPE ratios. Below, we outline several ETFs that offer exposure to these promising economies:

  • FTSE Greece 20 ETF (GREK, C): Since the eurozone debt crisis began, Greece has struggled to recover fully from its economic slump. And though a full turn around will likely take years, the country’s equities are currently trading at record low levels and could offer great potential for those willing to buy and hold these risky securities.
  • MSCI Ireland Capped Investable Market Index Fund (EIRL, B+): Like Greece, Ireland too has encountered significant bumps in the road amidst the debt crisis. However, Ireland currently has one of the lowest CAPE ratios, making now a great time to invest.
  • Market Vectors Russia ETF (RSX, B-): As one of the most commodity-rich economies, Russia may be an appealing option for those who believe the global economic recovery will come sooner rather than later. As global consumption returns and even surpasses its pre-recession levels, demand for commodities will likely rise, making equity markets of countries like Russia prime for capital appreciation [see BRIC-or-Bust ETFdb Portfolio].

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Disclosure: No positions at time of writing.

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