Long-term investors need international equity exposure. That's
the mantra repeated by the CFA Institute and by advisors
A new fund, the iShares Core MSCI EAFE ETF (NYSEArca:IEFA) is
marketed as an answer to this exact need. It covers developed
markets outside of the U.S.
It helps to grasp the broader context on IEFA by holding it up
to the largest ETF in the space-its sister fund, the iShares MSCI
EAFE Index Fund (NYSEArca:EFA). EFA has a massive asset base of
almost $37 billion, and its top-tier liquidity means that it's easy
and cheap to trade-even for novices.
But for long-term investors, IEFA has two structural advantages
over EFA. First, it has a much lower annual fee-0.14 percent vs.
EFA's 0.34 percent.
As a reality check, we at IndexUniverse harp on the fact low
fees don't necessarily mean low all-in costs.
And IEFA will indeed cost more to trade than EFA. IEFA is a
brand-new fund still seeking traction with investors, while EFA is
one of the most liquid
on the planet.
That said, IEFA's bid/ask spreads look manageable, so for
long-term investors, the lower annual holding cost should more than
offset trading costs.
IEFA's second improvement over EFA is wonkier, but it
Put simply, IEFA does a better job capturing the market. It
reaches further down the size spectrum of companies to include
That doesn't mean it's betting big on small firms. It simply
holds them in marketlike proportion, meaning they make up something
like 10 percent of the portfolio. In comparison, EFA and many other
competing funds lop off these smaller firms.
Index investing means owning the market, with the direct
implication that deviations from the market are effectively bets
In this light, EFA bets against international small-caps by
ignoring them. IEFA rights this wrong.
The Core Concept
What's the trade-off? Tradability. Because IEFA holds more
small-cap stocks, it's likely to be harder to trade, even after its
shakes off its new-fund status.
This trade-off highlights the iShares "Core" philosophy:IEFA is
one of 10 new iShares funds expressly designed for long-term
investors who aim for more accurate coverage of the target market
and that come with cheaper annual fees. But they'll cost a bit more
Still, IEFA isn't perfect for long-term investors. While it
offers deeper coverage than EFA by including smaller firms, it
doesn't improve on the breadth of coverage with respect to country
Like EFA, it omits all Canadian stocks.
Canada makes up about 10 percent of developed-market equities
outside the U.S. and includes major energy, basic materials and
IEFA also omits South Korea. The argument is definitional:IEFA
and EFA don't consider South Korea to be a developed market. I've
heard both sides of this point, but if I have to choose one
international equity fund, I want it to hold household names like
Samsung and Hyundai.
Returning to the indexing logic above, IEFA and EFA bet against
Canada and South Korea.
What Other Alternatives Are There?
You can complement IEFA with single-country ETFs that cover
Canada and South Korea, but this solution is cumbersome and
Single-fund solutions make more sense, but among the dozen or so
ETFs that compete, none delivers all the goods over the long
The Schwab International Equity ETF (NYSEArca:SCHF) includes
Canada and South Korea, but slights small-caps. SCHF is cheap to
hold and offers ample liquidity for long-term investors, so the
trade-off here is SCHF's superior breadth on country exposure vs.
IEFA's superior depth on firm size.
The Vanguard MSCI EAFE ETF (NYSEArca:VEA) is huge, cheap and
liquid, but it currently tracks the same index as EFA, meaning
suboptimal depth and breadth. VEA will include South Korea in the
first part of 2013, but will still lack small-caps and Canadian
Back To The Future
For long-term investors, I believe IEFA is a better choice than
EFA, but please trade with caution in these early days. That means
using limit orders rather than market orders. Consulting intraday
net asset value (iNAV) might help too, but bear in mind that many
underlying securities don't trade while the ETF itself is
Or wait a bit until the new fund gathers more investor
While IEFA is a solid choice for the long haul, I believe SCHF's
trade-off for country breadth over firm size depth gives it the
edge over IEFA and over the present and future versions of
At the time this article was written, the author had no
positions in the securities mentioned. Contact Paul Britt at
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