iShares Core MSCI EAFE IMI Index (XEF) tracks the MSCI EAFE Investable Markets Index, which includes 99% of the developed world’s market cap outside of North America. This broadly diversified benchmark better reflects active international managers’ hunting ground than the more widely used MSCI EAFE Index, which covers 85% of the developed ex-North America universe. The EAFE IMI’s all-cap complexion gives XEF more exposure to mid- and small caps than the International Equity category average; its $29 billion average market cap weighs in a bit below the $39 billion category average.
During the past decade, the index's correlation with the S&P/TSX Composite Index was 60%, while the typical fund in the category had a 67% correlation. With more than 2,000 holdings, position sizes are small, even among the largest companies; the top 10 holdings make up less than 15% of assets. Its heaviest sector concentration is financial services, which soak up 20% of assets. Consumer cyclicals and staples, healthcare and industrials names largely make up the rest, each sporting similarly sized weightings.
The largest concentration risks come from country and currency concentration. European stocks make up more than 60% of the portfolio, with half of this weighting tied directly to the value of the euro. The British pound comprises the lion's share of the remainder, making up roughly 20% of assets, followed by the Swiss franc, at approximately 8%. The next largest currency exposure is the Japanese yen, accounting for nearly a quarter of the fund. These numbers, though, likely overstate the benchmark's country and currency risks. The extensive global operations of its largest holdings, such as Nestlé (NSRGY), Toyota (TM), BP (BP) and Anheuser-Busch Inbev (BUD), means the fund is exposed to a larger range of country and currency markets than it appears at first blush.
In aggregate, the International Equity category mirrors the benchmark’s sector weightings, but it diverges in other respects. By including 99% of the available float-adjusted market cap in the EAFE universe, the benchmark holds all but the tiniest names in its hunting ground, leading to slightly above-average mid- and small-cap exposure. Most rivals have also been underweight chronic laggard Japan during the past decade; its peers hold 16% in Japan on average, versus 21% for the EAFE index. The competition also enjoys the flexibility to invest in emerging markets, with an average 8% emerging-markets weighting.
XEF's diversification advantages stem partly from its unhedged portfolio. By mandate or as part of management’s investment strategy, many rivals hedge or partially hedge their portfolio to Canadian dollars. While doing so protects investors against weakening currencies outside North America, Canadian-dollar hedging has led to higher volatility.
With a 0.22% management-expense ratio, XEF is one of the cheapest broad international index ETFs available in Canada. It also has a huge cost advantage over its category rivals: The median core international fund sold through fee-based advisors costs 1.29%. Low turnover minimizes trading expenses, bolstering the fund's cost advantage. Its 0.02% total-expense ratio in 2015 is far smaller than the 0.15% median for the category.
Alternatives
Silver-rated Vanguard FTSE Developed All Cap ex North America Index (VIU) tracks an all-cap, developed-markets index, though unlike MSCI, VIU's FTSE benchmark classifies South Korea as a developed market, leading to a 4% stake in the country. VIU's 0.21% MER is a hair below XEF's 0.22% levy.
Neutral-rated BMO MSCI EAFE (ZEA) tracks the large-cap-dominated MSCI EAFE Index. Its 0.25% MER is reasonable, though high trading costs undermine its appeal. U.S.-listed iShares MSCI EAFE (EFA) has tracked the benchmark more effectively and offers higher liquidity, but its 0.33% expense ratio and tax costs undermine these benefits. BMO MSCI EAFE Hedged to CAD (ZDM) and Canada-listed iShares MSCI EAFE CAD-Hedged (XIN) provide EAFE exposure without currency risk.
Bronze-rated iShares EDGE MSCI EAFE Minimum Volatility Index (XMI) holds roughly 200 stocks based on an estimate of each EAFE constituent's volatility. In contrast to PowerShares S&P International Developed Low Volatility Index (ILV), which is heavy on sectors like utilities and real estate, XMI keeps its sector weightings aligned with the EAFE's. (ILV doesn't provide pure international exposure, with an 18% Canada weighting.) XMI holds appeal on diversification grounds; its benchmark has been less correlated with Canadian equities than its market-cap-weighted sibling.
iShares International Fundamental Index ETF (CIE) attempts to capture the value premium. Its FTSE RAFI benchmark weights stocks based on fundamental factors like dividends, cash flow and book value, resulting in a value tilt. The FTSE RAFI indexes have fared well versus market-cap-weighted rivals, but CIE's steep 0.72% MER makes it harder to compete.
