Welcome to another edition of the ETF Insights newsletter. To say April was a volatile month is an understatement. Many investors are now questioning the reliability of US equities now that the country is putting aggressive tariff measures in place in what can only be viewed as one of the more confusing economic policies in many years.
We’ve started to see the inflows into international ETFs increase relative to US equities. I think more and more investors are now looking to get exposure outside of North America. Previously, this was an afterthought for many, as North American equities provided returns strong enough that they never wanted to look elsewhere.
Fortunately, investing in international markets is easy with the introduction of exchange-traded funds. While picking and choosing international companies can be enough to make even experienced investors’ heads spin, we can now do it in a few clicks of a button and be well diversified, mitigating risk.
In this month’s newsletter, I’m going to be diving deep into international exposure, including allocation strategies, the risks and rewards of investing in particular countries, and what funds would be best for those looking to get exposure.
Let’s waste no time and dive right into it.
The case for global diversification via ETFs
One of the more common tactics has always been investing in what you know. Some investors do this appropriately, with a properly diversified portfolio. However, others will build out a portfolio that is biased towards Canada or the United States.
For the most part, this has worked out. North American equities, primarily those south of the border, have provided nothing short of outstanding returns since the financial crisis.
However, there are some macroeconomic trends and also some uncertainty in the US that are painting a promising picture for emerging and developed markets outside of North America.
The Federal Reserve is likely going to enter a period of rate declines over the next few years here, which should, in turn, weaken the US Dollar. I won’t go into the intricacies as to why this helps international markets, as I’d more so like to speak on those markets themselves individually, but just know that a weaker US Dollar typically helps these countries as it makes their debt servicing cheaper and they can ultimately free up room for more economic stimulus, among other things.
US GDP is expected to grow at a 1.9% pace in 2025, which is down from previous forecasts of 2.8%. Emerging markets, on the other hand, are expected to experience much higher growth than this, potentially exceeding 4% in some regions like South Asia and Africa.
Emerging and developed markets are picking up steam in terms of inflows
If you’ve been thinking of adding emerging or developed market funds to your portfolio, you’re not alone. If we look to Blackrock, which is one of the largest asset managers in the world and the operator of the iShares ETFs, inflows into EMEA (Europe, Middle East, & Africa) were 41% of their ETF inflows last quarter. Over the last year, they’ve been 32% of total inflows.
Below is a highlight from Blackrock’s quarter, which shows that out of the $83B in inflows, $36B, or 43.3%, are to EMEA.
So, we’re clearly seeing a shift towards emerging and developed markets outside of North America. This is likely due to the volatility in US equities and the potential for a US recession over the coming years.
Whether or not this trend continues is difficult to say. However, we shouldn’t concern ourselves too much with short-term trends, and instead develop a long-term mindset when it comes to investing in these markets.
So you want international exposure, but what countries are best suited for your money?
Investing in North America is relatively simple. We have two primary countries, Canada and the United States. However, when we venture outside of North America, we’re exposed to a multitude of countries and it tends to become a bit overwhelming.
In this section, I want to dive into particular countries and give you some insights on the potential pros and cons of each. After that, I will provide an ETF that I think is the industry leader in terms of exposure.
India
Out of all the international markets, I would argue that India is the most attractive, so I will go over it first. While you will see when I cover the European and Japanese markets, they’ve been plagued by low productivity and an aging demographic. India has neither of these issues but does have some challenges, which I’ll go over.
The pros
India’s economy is set to explode in 2025, with GDP growth exceeding 6.5%. This is in stark contrast to places like the United States and Europe, which are expected to have a bit of a stall out in terms of GDP. Look to the chart below for a visual example.
In addition to this, the country has a young and growing demographic, which typically leads to more workforce utilization and higher productivity.
The country is also home to some of the most promising software and fintech companies in the world. If we look to a major technology leader in Alphabet, it has made numerous acquisitions out of India over the years due to their promising growth prospects.
The cons
When I go over the European and Japanese markets, you’ll notice that their equities trade at discounts to US equities. However, this is the opposite for India. While the S&P 500 trades at 18x expected earnings, the Indian markets are currently trading at 22x. This is much higher than many global averages. Although you’re getting exposure to a faster-growing economy, you’re certainly paying for it.
The other issue here is that India relies extensively on imports, which leaves it vulnerable to pricing fluctuations. Although imports are a way of life in the economies of today, too much reliance on external countries can make a nation susceptible to considerable volatility in its economy.
The case for buying
One of the main cases would be the demographic. India has a median age of 28. Compare this to 38 for the United States and 48 for Japan, and you have a young and willing workforce that will ultimately fuel strong economic production. Young populations tend to prop up the economy, as it keeps demand high for housing, consumer goods, and infrastructure expansion.
In addition to this, they have a rapidly growing economy, one that is primarily fueled by consumption, which is the more sustainable method of economic growth.
The fund for exposure
Unfortunately, there are few options for Canadian investors to get exposure to the markets in India in terms of ETFs. I’d argue that there is only one of high quality, which is the BMO MSCI India Selection Equity Index ETF (ZID.TO).
iShares does have a fund, but BMO’s has performed much better and has much lower fees. Overall, ZID will give you exposure to around 60 of the highest-quality companies in India and is a great fund.
Europe
Europe would be more on the “developed” side of international exposure rather than “emerging.” At this point in time, European equities are trading at steep discounts to US equities. On average, European stocks trade at around 12x expected earnings. Meanwhile, the S&P 500 is at 18x.
The Pros
One of the primary reasons for this is how badly the European economy was beaten down by the pandemic, plus the energy shock that resulted from the Russia/Ukraine conflict. Inflation was sky-high in Europe, at one point exceeding 11.5%. However, inflation is cooling, manufacturing is improving, and consumer sentiment is starting to turn around.
The Cons
The cons? Expected growth is low, with GDP expected to grow only around 1% in 2025. The European markets certainly have a lot of potential, but they’ve been operating well below it for many years. The country is not nearly as productive as the United States, which is certainly showing. There is also the added element of geopolitical uncertainty in the region that could potentially keep European stocks trading at a discount.
The case for buying
European countries make up some of the largest powerhouses in the world. At this point in time, you are paying a significantly lower price for high-quality European equities than US equities. If this value gap were to close even slightly, there is some solid upside potential here. However, the European economy would need to pick up steam, as 1% GDP growth is not that impressive.
The fund for exposure
I am a fan of the Global X Europe 50 Index Corporate Class ETF (TSE:HXX). This fund is much the same as the S&P 500 Corporate Class ETF (TSE:HXS) in the fact that instead of paying a dividend, the fund lumps everything together as a simple return on its share price. From a taxation perspective, this is attractive to many investors.
For the fund itself, it is relatively simple. You will gain exposure to the 50 largest companies in the Eurozone, including companies like SAP, Siemens, Schneider Electric, ASML Holdings, and Air Liquide.
Think of this as the TSX 60 index, which comprises the 60 largest companies in Canada, but instead, the exposure is in Europe.
Japan
Japan is a tricky one. The country’s index, the NIKKEI, went through a prolonged period of effectively dead market returns. And by prolonged, I mean the index traded at the same levels in 2017 than it did in 1996.
The country had a significant issue in terms of deflation and a weak economy. However, it seems to be turning the corner, with economic activity picking back up, a weaker currency fuelling exports, and corporate governance that should fuel market valuations.
The pros
Again, one of the main pros here is valuations relative to US Equities. While US equities trade at 18x earnings, Japanese equities sit at around 14x. This is even after a large rise in Japanese equities over the last 5 years, with the index returning nearly 90%.
In addition to this, the political and regulatory environment for Japan is stable and predictable. The country is one of the largest economies on the planet.
The cons
Japan has been plagued by consistent deflation. Because of this, investment opportunities in the country have not exactly been all that promising. GDP growth is virtually non-existent, primarily because of demographical issues. The population in Japan is simply too old. In fact, it is the oldest population in the developed world, with an average age of 48.
This has resulted in a persistent decline in the overall working population, which has reduced labor inputs and overall spending.
The case for buying
Japanese companies have been long known for hoarding cash and maintaining relatively poor operations. However, market reforms are putting pressure on these companies to start returning capital to shareholders and investing in more growth.
If this continues, it will likely make the Japanese markets more attractive to investors, shifting the sentiment from a dead market to one that can generate returns for investors efficiently.
The fund for exposure
We don’t have a lot of funds here in Canada that track the Japanese market. In fact, I can count them on one hand. However, I do believe one of the best funds here in Canada is the Bank of Montreal’s Japan Index ETF (TSE:ZJPN).
It is a relatively new fund, starting in early 2022, as you can see by the chart, and has kept up with most major indexes in North America over the last few years.
If you want a currency-hedged version, they have ZJPN.F. The unhedged fund hasn’t performed as well as some hedged variants here in Canada. However, currency hedging is something that is ultimately up to the individual.
This fund will give you exposure to some of the premiere Japanese stocks, including Toyota, Mitsubishi, Sony, Hitachi, Nintendo, and more.
Why I didn’t include China
There is no doubt that China’s economy is a global superpower. However, I have excluded it from this list primarily due to the fact I’ve never liked the regulatory and political situation in China. Combine this with the current trade war and tariff risks with the United States, and I’m not particularly bullish on the country.
Which country looks the most promising?
It is hard to deny that an investment in India could provide a lot of promise. The country is performing exceptionally well, has a workforce that should no doubt lead to outsized economic production, and it is expected to grow its economy at one of the faster paces of all countries.
The country is not without risk, however, as the markets there typically trade at premium valuations because of its growth, which leaves little room for error.
What most investors likely should do
I provided some individual ETFs for specific countries if you’re looking to do a bit more digging and get some individual exposure.
However, this does require extensive research and knowledge of the economies in those countries. For most investors, and maybe this applies to yourself if you are a passive ETF investor, an all-in-one international solution is likely going to be what you’re looking for.
One of my favorite international ETFs, and one that is a highlighted fund here at ETF Insights, is the iShares Core MSCI EAFE IMI Index ETF (TSE:XEF).
The one issue in this regard is it does not contain a large amount of exposure to India. However, one could easily mitigate this by just buying the BMO India ETF I highlighted above.
While international exposure is good, it is important to temper expectations
International markets are promising, and the story behind a lot of these countries is certainly one of growth. However, history has shown that economic growth and high productivity are not guaranteed to lead to outsized returns.
US equities are likely to remain the premier destination in investment for the foreseeable future, and it is important that you don’t go too crazy in terms of portfolio allocation to international equities.
The guidance you will get varies from analyst to analyst, but most state that 10-15% exposure to emerging and developed international markets is somewhere around the sweet spot.
However, a lot choose to have 0% exposure, primarily because they simply do not understand the economies of these global countries. That is also perfectly fine, as ultimately, we need to invest in things we’re comfortable with. However, with funds like XEF and the other international ETFs, it is now becoming easier to get broad exposure, which could reduce volatility.
