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Country or region? Pick a focused ETF wisely

Nation-specific funds offer broad exposure to countries with surging markets, yet investors may be better off with a regional approach

By: JOEL SCHLESINGER

Date: October 18, 2017

Exchange-traded funds are a great way to get low-cost, diversified exposure to markets in foreign countries.

But how narrowly should investors focus on a country or region? It's a debate that invites multiple viewpoints among investment professionals specializing in ETF strategies.

Dan Bortolotti, associate portfolio manager with PWL Capital in Toronto, says one challenge with nation-specific ETFs is that "no one really knows which countries will outperform, so it's mostly guesswork to be overweighting some while excluding others."

A better solution might be to choose a global diversified strategy by holding perhaps three ETFs that provide diversification across several nations. Still, for Canadian investors, he does make a couple of exceptions.

Oh, Canada

The most obvious country-specific choice for Canadians is to own an ETF providing exposure to Canada, "since there may be good reasons to overweight one's own country in a global portfolio," says Mr. Bortolotti, who is also the author of the popular Canadian Couch Potato investing blog.

For one, currency risk is largely eliminated because you are investing with Canadian dollars in Canadian assets.

Moreover, Canadians have plenty of choices among low-cost options. Among them are the iShares Core S&P/TSX Capped Composite Index ETF, which has a management expense ratio, or MER, of 0.06 per cent and provides exposure to about 250 Canadian publicly listed companies. Another is the Vanguard FTSE Canada All Cap Index ETF, which also has an MER of 0.06 per cent and holds 220 Canadian stocks.

Star-spangled earnings

The next choice is the United States, "far and away the largest market in the world, representing just over half of the global market cap," he says. "By using a separate ETF for your U.S. equity holdings, you can get complete coverage of the market."

Some offer exposure to thousands of large—, mid— and small-cap stocks at low cost compared with a global ETF that includes U.S. stocks.

Choices are plentiful, too. Among them is Vanguard's U.S. Total Market Index ETF. For an MER of 0.16 per cent, investors get exposure to more than 3,600 publicly listed firms — from Apple Inc. to small biotech and technology companies.

Across the Pacific

Country-specific ETFs are useful for investors seeking to buy certain markets overlooked by others, says Tyler Mordy, chief investment officer at Forstrong Global Asset Management. Two in particular come to mind.

One is China. Sure, it's not growing like it once did — it's no longer the world's second-largest economy experiencing GDP expansion of about 11 per cent annually, its average growth between 2002 and 2011. These days, its economy is lucky to achieve 7 per cent growth. Still, that's much faster than Canada and the United States.

Moreover, the slowdown is by design. "China's new path is driven by broad recognition that the growth model of the last 30 years is neither balanced nor sustainable," Mr. Mordy says. Cheap labour and products are no longer sufficient. Middle-class wealth and higher productivity, with a greater focus on high-tech manufacturing, are the way forward.

China's economy will naturally slow while making this transition, which Mr. Mordy suggests is why now is an ideal time to buy low. As such, he says the iShares China Large-Cap ETF is a good long-term option, even if the bears have short selling positions to the tune of about $1.28-billion. "Now is the time to be investing in an unloved sector," he says. "As China makes progress in the face of the many naysayers, equities have lots of room to be revalued upward."

Japan is another nation renowned for economic headwinds.

"To be sure, Japan faces some serious structural issues — high debt levels, aging demographics," Mr. Mordy says. But 25 years of grappling with an overvalued currency and chronic deflation have made Japanese companies lean and efficient. They "also happen to sit atop $4-trillion U.S. in cash," he says, meaning firms can expand without taking on debt.

The iShares MSCI Japan ETF provides broad exposure to its stock market — more than 300 companies — including some of the world's leading innovators in biotechnology, robotics and advanced manufacturing.

"In the words of one analyst, 'They make cool stuff,'" Mr. Mordy says, adding that currency hedging is unnecessary. "The yen is the cheapest in 30 years … perfect conditions to go long."

Bullish on the bear

Portfolio manager Mark Yamada, president of PUR Investments in Toronto, says Robert Shiller, the Yale University professor and Nobel Laureate in economics, recently spoke in Toronto and mentioned that Russia's stock market is undervalued. In other words, Russian stocks may have a lot of room to grow in the future, Mr. Yamada says.

Still, he warns the comment should be taken in context: Investing in Russia requires a long-term view and a stomach for volatility. Investors could buy the VanEck Vectors Russia ETF. It is the most liquid of Russian ETFs traded on North American markets, but "with 39 per cent energy, 16 per cent basic materials and 15 per cent financial, it also feels rather Canadian," Mr. Yamada says.

Moreover, the MER of 0.65 per cent is much higher than Vanguard's FTSE Emerging Markets Fund, which includes Russian companies and has an MER of 0.14 per cent.

Dollars for Deutschland

Germany has been a bastion of economic and political stability in Europe, and its stock market reflects this strength. Year to date, the benchmark MSCI Germany Index is up about 25 per cent.

Investors can get exposure to the German market through a variety of ETFs, including the iShares MSCI Germany, or its U.S.-dollar-hedged version. But Mr. Yamada says most Germany-specific ETFs are pricey compared with a broader European ETF.

For example, the iShares Core MSCI Europe ETF has an MER of 0.1 per cent. The downside is it has higher market-cap exposures to Britain and France than to Germany, "so political and economic union risks must be considered."

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