The addition of international exposure to a portfolio is supposed to decrease its volatility while adding alpha over time. Historically, as U.S. markets retreat European, Asian and Far East (EAFE) markets tend to rise. Recent history has proved the opposite to be true, however. Assets that once moved in opposite directions have begun to rise and fall in unison.

The cause of this anomaly can be traced back to the credit crisis in the U.S. mixed with global fears of inflation, and U.S. companies increased exposure to revenues from overseas markets. Investors relying solely on EAFE Indexes as a counter to the S&P 500 may consider adding a safety in the form of a short-focused ETFs (inverse ETFs) or extend their investment horizon.

Recent Returns
The iShares MSCI EAFE ETF (AMEX:EFA) is down nearly -19% since the beginning of the year while the S&P 500 is down just over -17%. In order to counter this short term correlation an investor would need to hold the Short MSCI EAFE ProShares (AMEX:EFZ), which increases in value when the MSCI EAFE Index falls. The EFZ ETF returned nearly 16% during the same time period. Since we're not short term investors lets take a closer look at the recent problems of a few EAFE economies and how the EAFE index has performed over a longer period of time. (For more on this type of exchange traded fund, read our related article Inverse ETFs Can Lift A Falling Portfolio.)

EAFE Insight
The EFA ETF is very well diversified over its 817 holdings. At the end of June more than 50% of its holdings are derived from Japan, the U.K. and France. Familiar names among its top 10 holdings include Toyota Motors (NYSE:TM) of Japan, Nestle of Switzerland, and HSBC Holdings (NYSE:HBC) of the U.K.

  • Japan - Japan is going through economic difficulties of its own in the form of rising unemployment and stricter spending habits from consumers who have not been immune to rising energy and food prices. Fewer disposable dollars for U.S. consumers also limit the revenue of Japan's automobile and electronic manufactures.

  • The U.K. - An economic slowdown in the U.K. has been tied to declining sales in real estate and overall business activity. The economy grew by only 0.2% for the second quarter, the slowest rate for the country since 2001.

  • France - The French economy is also expected to expand at its slowest rate in the past five years at 1.6%. Inflation in the form of rising energy and food prices along with slowing real estate sales have also help to slow the economy.

Going International Still Worth It?
The benefit of holding the EFA ETF is easily seen once we extend our holding period. Over the past three years the EFA ETF is up over 21% while the S&P 500 is down just under 1%. The S&P 500 index can be tracked in a portfolio by holding the SPDRs ETF (AMEX:SPY).

International exposure is a must for any portfolio with an extended period of time to recover from short term pullbacks. It's also good to know that investors with shorter time horizons can buy some protection by focusing on ETFs that rise when international indexes fall.

To learn more, read Go International With Foreign Index Funds.

Related Articles
  1. Mutual Funds & ETFs

    Pimco’s Top Funds for Retirement Income

    Once you're living off the money you've saved for retirement, is it invested in the right assets? Here are some from PIMCO that may be good options.
  2. Chart Advisor

    Watch This ETF For Signs Of A Reversal (BCX)

    Trying to determine if the commodity markets are ready for a bounce? Take a look at the analysis of this ETF to find out if now is the time to buy.
  3. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  4. Mutual Funds & ETFs

    ETFs Can Be Safe Investments, If Used Correctly

    Learn about how ETFs can be a safe investment option if you know which funds to choose, including the basics of both indexed and leveraged ETFs.
  5. Mutual Funds & ETFs

    The Top 5 Large Cap Core ETFs for 2016 (VUG, SPLV)

    Look out for these five ETFs in 2016, and learn why investors should closely watch how the Federal Reserve moves heading into the new year.
  6. Economics

    India: Why it Might Pay to Be Bullish Right Now

    Many investors are bullish on India for all the right reasons. Does it present an investing opportunity?
  7. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  8. Investing Basics

    Building My Portfolio with BlackRock ETFs and Mutual Funds (ITOT, IXUS)

    Find out how to construct the ideal investment portfolio utilizing BlackRock's tools, resources and its popular low-cost exchange-traded funds (ETFs).
  9. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  10. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>
Trading Center