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Look Before Leaping Into International ETFs

Investors can diversify a portfolio with international stock exchange traded funds, but before diving into overseas investments, people should take a moment to consider some factors.

“To make good decisions about your foreign-stock holdings, it’s important to give some consideration to the amount of initial research and ongoing oversight you’re willing to dedicate to your portfolio, how much volatility you’re willing to tolerate, and whether you want to shoot for market-beating performance or are comfortable holding an index basket of foreign stocks,” writes Christine Benz, Morningstar‘s director of personal finance.

Investors should consider what type of investment vehicle they are comfortable with, costs, market exposure and currency risks.

To start off, an investor can select individual securities, or simply go with a broad fund. For example, the Vanguard FTSE All-World ex-US (VEU) , with $12.7 billion in assets under management, is the largest ETF to focus on international markets and tracks 2,330 different global company stocks. The iShares MSCI ACWI ex U.S. ETF (ACWX) also tracks markets outside the U.S. and includes 1,061 components. The ETFs provide a simple way to cover a diverse range of international securities.

Additionally, instead of accumulating trading fees on a number of international stock picks, an investor would only have to pay for the commission-fees of a single ETF trade.

Alternatively, investors may also consider an actively managed fund option to capitalize on an asset manager’s expertise. For instance, the actively managed iShares Enhanced International Large-Cap ETF (IEIL) uses quality, value and size factors to seek out long-term capital appreciation. However, active ETFs are slightly more expensive than their passive, index-based counterparts. IEIL has a 0.35% expense ratio while VEU has a 0.15% expense ratio. [iShares Introduces Two New ETFs Thursday]

With ETFs, investors can also break down international exposure to developed and emerging markets. For instance, the iShares MSCI EAFE ETF (EFA) and Vanguard FTSE Developed Markets ETF (VEA) both track developed markets outside of North America. On the other hand, the iShares MSCI Emerging Markets ETF (EEM) and Vanguard FTSE Emerging Markets ETF (VWO) provide access to the world’s developing economies.

“Because emerging markets tend to have higher volatility than developed, they can circumvent emerging markets altogether–investing in an MSCI EAFE fund or an actively managed fund that systematically downplays emerging markets,” Benz added. “On the flip side, if they’re enthusiastic about emerging markets, they can layer on a dedicated emerging-markets fund or invest heavily in a diversified foreign-stock fund that buys heavily into emerging markets.”

Lastly, potential investors should be aware of currency risks associated with overseas exposure – depreciating local currencies would mean that any returns are lower in U.S.-dollar-denominated terms. Nevertheless, there is a growing number of currency hedged-equity ETFs on the market. Among the more popular Europe plays, the Deutsche X-Trackers MSCI Europe Hedged Equity ETF (DBEU) , iShares Currency Hedged MSCI EMU ETF (NYSEArca: HEZU) and WisdomTree Europe Hedged Equity Fund (HEDJ) hedge against the euro currency and would outperform a non-hedged Europe equity ETF if the euro currency depreciates. [ Europe ETFs Can Turnaround Next Year]

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article. Tom Lydon’s clients own shares of EFA.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.