SPDW - IEFA: Consider These Dividend And Value Alternatives

2023-08-22 02:33:54 ET

Summary

• IEFA is a large and efficient ex-US/Canada developed markets index fund.
• Though it charges a low expense ratio, investors can find even cheaper funds.
• If you are looking for a methodology that emphasizes value or yield performance, there are also some alternatives for you to consider.

Thesis

iShares Core MSCI EAFE ETF ( IEFA ) is the biggest U.S.-based index fund that allows you to track the developed markets outside North America for a low cost. Investors who have a long-term horizon will find this ETF to be adequate for passive investing.

It is a decent vanilla ETF and has delivered even better than expected so far. But because of my personal needs and the availability of alternatives that can better cover those needs, I would have to pass.

In this article, I will show you these alternatives. Some are cheaper and some are older. In addition, if you are sensitive to the idea of overpaying for international exposure right now, there are two other ETFs whose holdings are net valued lower on both an earnings and assets basis. One of them can also be bought at a potentially attractive yield right now.

What Does IEFA Do?

IEFA is an ex-US/Canada developed markets index fund launched by BlackRock, Inc on October 18, 2012 and managed by BlackRock Fund Advisors. It charges a modest expense ratio of 0.07% and currently has about $97.35B in assets under management.

Its goal is to replicate the performance of the MSCI EAFE IMI Index using a representative sampling technique. This index tracks the performance of small-, mid-, and large-cap stocks issued in the developed markets of Europe, Australasia, and the Far East. Additionally, it's a free float-adjusted and market-cap-weighted index.

As of August 16, 2023, the fund holds 3,002 stocks and is mostly exposed to NESTLE SA (portfolio allocation: 1.83%), NOVO NORDISK CLASS B (1.72%), ASML HOLDING NV (1.49%), LVMH (1.36%), ASTRAZENECA PLC (1.20%), NOVARTIS AG (1.18%), ROCHE HOLDING PAR AG (1.17%), SHELL PLC (1.15%), TOYOTA MOTOR CORP (0.97%), and HSBC HOLDINGS PLC (0.84%).

Regarding the sectors, IEFA is mostly exposed to Financials (17.52%) and Industrials (16.94%). Geographically, it has 23.48% allocated in Japan, 14.70% in the U.K., 11.14% in France, 11.14% in Switzerland, 8.07% in Germany, and 7.54% in Australia.

Now, this is an ETF that caters to those looking to get exposure to developed markets outside North America. With many Americans being already exposed to the U.S. equity market through tracking an index like the S&P 500, IEFA can be a practical way to diversify further without causing any portfolio overlapping.

But before you make an investment decision, there is an important question you should ask; is this the best way to acquire that exposure?

Performance

First of all, let's take a look at the fund's performance against its benchmark. Since its inception, it has returned an average of 6.06% per year on a market-price basis. The index increased by an average of 5.83% annually. This outperformance is quite significant considering the long period in which it was realized.

Let's now examine some other ETFs that are supposed to do the same job. Below, you are looking at a chart of the past total market price performance of IEFA against both vanilla and smart-beta ex-North America developed markets ETFs.

Evidently, IEFA's performance is average when compared to the funds above. The only thing that stands out is a USD-hedged developed markets ETF that has significantly deviated from the rest of the pack. It's the Xtrackers MSCI EAFE Hedged Equity ETF ( DBEF ) and is more concentrated than IEFA, currently holding 812 stocks.

However, as you might have already noticed from the graph above, most of the outperformance comes during a historic period in which the U.S. dollar strengthened against multiple currencies. So, take the historical outperformance with a grain of salt as it may be offset by a net weaker USD in the future.

In conclusion, if you are looking for an advantage related to performance, it's likely you won't find any here. Most of those funds are market-cap weighted and overlap with varying degrees of diversification.

With that being said, your best bet would be the iShares MSCI Intl Quality Factor ETF ( IQLT ) because of its quality criteria and more concentrated portfolio (323 holdings). As we can see from the chart above, it returned about 61% in the last 7 years or so, while IEFA returned about 53%. It's not unreasonable to expect that this performance difference will keep widening because of the bias towards quality stocks. However, I wouldn't hold my breath for anything extraordinary.

Of course, there's also the matter of fees to be considered here. While IEFA charges a 0.07% expense ratio, IQLT charges one of 0.30%. Whether paying more than three times for this smart-beta approach is worth it entirely depends on your goals and holding period. Speaking of fees and personal goals, let's make a comparison.

Fees

I thought I'd make a table comparing the costs of the same funds we used for the performance assessment above for those who may be looking for the cheapest fund possible within a specific AUM range target and a minimum track record.

Obviously, you cannot go wrong with the Vanguard FTSE Developed Markets Index Fund ETF Shares ( VEA ); it's the second-cheapest one with by far the largest AUM size. Or you could go for the cheapest option; the SPDR Portfolio Developed World ex-US ETF ( SPDW ). But if you place more trust in the track record, iShares MSCI EAFE ETF ( EFA ) was launched as early as 2001.

Yield and Value

IEFA currently has a 2.68% SEC yield. Predictably, a lot of the alternative options sport more or less the same. The ones that stand out are the iShares MSCI EAFE Value ETF ( EFV ) with a 3.58% yield and the iShares International Select Dividend ETF ( IDV ) with one of 6.65%.

Both have underperformed IEFA by a great margin as we witnessed above. The disparity is in fact so significant that you may find that the potentially higher income won't be worth the potential opportunity cost during a bull market.

For long-term exposure, however, I personally appreciate the sense of certainty a value tilt ETF provides. When I talk about "certainty" I refer to the kind that I don't overpay for something that is supposed to act as a portfolio diversifier.

That even goes beyond long-term exposure for me, though. Because of my inability to time the market and my unwillingness to even try, it doesn't really matter how long I will hold the fund to appreciate the value tilt. The past couple of years are in no way indicative of where the market is heading for the next couple and therefore I cannot place as much weight into past performance/similar future market dynamics as in a value methodology that ensures I don't overpay for earnings and underlying assets.

IEFA has a P/E ratio of 13.78 and a P/B ratio of 1.65 while EFV has one of 9.80 and 1.15, respectively. Even better, IDV has P/E and P/B ratios of 5.36 and 0.86, respectively. If I wanted exposure to globally developed markets right now, I would select IDV because of the steep discount its holdings are offered at. But I would be monitoring it for any significant change in the short term that would make it less appealing than EFV valuation-wise and invest in the latter in such a case. Because right now, the low valuation of IDV's holdings is an after-effect of the dividend tilt methodology and I have less trust in an after-effect than a value-tilt strategy. If I didn't want to bother with this more active approach in the short term, I would just buy EFV and hold.

With that being said, a few things that should be noted here:

• EFV and IDV are more concentrated in Financials than IEFA (about 27% of the portfolio versus 17%)
• Rio Tinto PLC and BHP GROUP LTD have a 5.03% and 3.32% weight, respectively, in IDV
• IDV has a similar geographical allocation profile to that of IEFA, but IDV looks very different with the inclusion of the Canadian equity market, in which it has a 10.46% weight, the second largest allocation after the U.K.

In other words, you can't have it all. The more you seek value, the less perfectly you'll be tracking the stock market. IDV is an extreme example of this by greatly exposing you to Canada which accounts for only 2.7% of the global equity market. I personally don't mind but you may do if you're either already exposed to Canada or you'd prefer a better representation of the global market, so I had to make certain you are aware of it. A more balanced exposure between the developed markets and value is offered by EFV.

Risks

ETFs like IEFA come with risks that are no different than the ones U.S. index funds involve:

• Stock market risk: The countries of the companies in which the ETF invests are subject to possible events that could negatively impact their equity markets, such as political changes, new regulations, war, etc.
• Industry concentration: There is no policy to restrict the fund from being concentrated in a certain industry; reasonably so, in order to match the benchmark's performance as closely as possible.
• Currency Risk: This is an ETF that invests in non-US stocks with its NAV calculated in US dollars; for this reason, an investor is exposed to the relative fluctuations of multiple foreign currencies (reminder: DBEF hedges against this risk).

For a full list of the risks involved, please refer to the fund's prospectus .

The Verdict

All in all, I appreciate the value IEFA offers here and I would have no problem holding it indefinitely if I wanted to. It's by far the greatest U.S.-based ETF of its kind with great liquidity and it's been more than efficient in giving investors the exposure they seek.

With that being said, I have an aversion to overpaying for stocks whether I buy them from inside or outside a fund. The dividend- and value-tilt ETFs that I discussed above seem more attractive to me for this reason.

But I would like to know what you think. I'm certainly looking forward to getting my views challenged. Do you hold IEFA or prefer something else? Also, please take the time to leave a comment if you found this post useful. As always, thank you for reading.

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