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Keep The International Stocks, Ditch The Volatility

ETF Professor

Developed markets stocks, including those in the United States, are struggling this year, but the situation is worse for ex-U.S. fare. The MSCI EAFE Index, one of the most widely followed gauges of ex-U.S. developed markets equities, is lower by nearly 13 percent year-to-date.

If there's good news, it's that markets outside the U.S. remain attractively valued relative to major domestic benchmarks. Investors looking to nibble on some international fare may want to consider a low volatility strategy.

What Happened

Low volatility exchange traded funds aren't confined to U.S. equities. The strategy is applied across geographies with plenty of success as highlighted by a more than seven-year track record for the iShares Edge MSCI Min Vol EAFE ETF (CBOE: EFAV), which has $8.83 billion in assets under management.

EFAV is doing the job that low volatility ETFs are supposed to do when markets swoon: be less bad than traditional indexes. The iShares ETF is down just over 4 percent year-to-date, significantly less bad than the MSCI EAFE Index.

“The fund tracks the MSCI EAFE Minimum Volatility Index. Its construction process starts with all stocks in the MSCI EAFE Index, and it uses an optimizer to select and weight stocks in a way that minimizes the portfolio's expected volatility while honoring several constraints,” said Morningstar.

Why It's Important

In addition to accomplishing the goal of performing less poorly when markets decline, EFAV does live up to its low volatility billing. The fund has a three-year standard deviation of 8.74 percent compared to 11.12 percent on the MSCI EAFE Index. EFAV's weighting methodology features some individual security and sector-level constraints.

“It has had a persistent overweighting in firms from traditionally stable sectors like consumer staples and utilities, while underweighting those from more volatile sectors like technology and energy,” said Morningstar.

EFAV allocates 24.44 percent of its weight to the consumer staples and utilities sectors while energy and technology names combine for just 4.54 percent of the fund's weight.

What's Next

Past performance is never a guarantee of future returns, but EFAV's track record does bode well for the fund, particularly if volatility remains high.

“The fund's approach has successfully achieved its goal of reducing risk. From its launch in October 2011 through June 2018, its volatility was 23% lower than the MSCI EAFE Index, allowing its risk-adjusted returns to easily beat this same bogy,” according to Morningstar.

The research firm has a Silver rating on EFAV.

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