(09/28/11) A Slew of New International Index Funds

Ten years ago, investors who wanted to buy an index fund that invested outside the United States had a fairly simple decision to make, since there were only four main contenders, but times have changed, writes Gregg Wolper of Morningstar.com.

In those less complicated times, Fidelity Spartan International Index (FSIIX) and Vanguard Developed Markets Index (VDMIX)—like quasi-index fund Vanguard Tax-Managed International (VTMGX)—all tracked the MSCI EAFE Index.

Schwab International Index (SWISX) added a twist. Instead of tracking the MSCI EAFE Index, it owned the 350 biggest companies outside the United States, which gave it a slightly different portfolio…though the differences were not dramatic. Meanwhile, Vanguard Total International Stock Index (VGTSX) added an emerging-markets component to the standard EAFE portfolio.

Although these funds were much cheaper than actively managed alternatives, they weren’t the bargains they later became. The annual expense ratio for the Schwab fund was around 0.5%, and the Fidelity Spartan option cost 0.35% per year.

The two Vanguard funds were less costly, but even that was not easy for investors to know, because as funds of funds they published an expense ratio of zero. You had to dig a little to learn the combined cost of the underlying funds.

Meanwhile, investors looking for an index fund that owned both US and foreign stocks—a global fund—were out of luck.

Things have changed on all three fronts. The number of alternatives for broad foreign index investing has exploded in the past few years. Global index funds now exist. Finally, in many cases the cost of these funds has dropped sharply.

Overall, these developments can be seen as positive. Investors can choose from many more international index funds, providing a broader diversity of approaches, and in some cases for substantially less money.

But investors must be careful, too. Narrowly focused choices can raise the risk level, and not all of the new entrants are bargains.

Vanguard Expands its Lineup
Instead of sticking exclusively with MSCI indexes when choosing its benchmarks for its broad funds—as well as regional offerings like Vanguard Pacific Stock Index (VPACX)—Vanguard branched out from 2007 to 2009.

Vanguard officials said that some advisors preferred indexes from another provider, FTSE. So, you can now select Vanguard FTSE All-World ex-US Index (VFWIX) for broad foreign exposure.

In addition, investors can target small stocks with Vanguard FTSE All-World ex-US Small Cap Index (VFSVX). The latter is the first foreign small-cap index fund of any kind from Vanguard.

In addition, for indexing fans who’d rather buy just one fund to cover both the US and foreign stocks, Vanguard created Vanguard Total World Stock Index (VTWSX). This also follows a FTSE benchmark.

Each of these funds has its own quirks and some distinctions from the previously existing alternatives from Vanguard and others. Outlining all of those factors would take too much time here, but the analyses for these funds, available to Premium subscribers, can help.

Meanwhile, starting last autumn, Vanguard created Admiral shares for most of its international index offerings, and cut the minimum for those shares to $10,000. These shares are even cheaper than the already-inexpensive Investor shares.

NEXT: Fidelity and Schwab Haven’t Been Sitting Still

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Fidelity and Schwab Haven’t Been Sitting Still
One reason Vanguard felt compelled to cut the fees on its funds was that competition in the index-fund arena, both in number of funds and in their costs, has reached a level hard to imagine a decade ago.

A landmark was Fidelity’s decision in 2004 to slash the annual expense ratio on its EAFE-tracker, Fidelity Spartan International Index, to just 0.10%. That made it significantly less costly than Vanguard’s similar funds.

However, for years Fidelity did not expand its line of international index funds beyond that one choice. That changed this summer.

The firm announced it will come out with two new index trackers: Fidelity Spartan Emerging Markets Index and Fidelity Spartan Global ex US Index. The latter will go beyond the EAFE countries, like Vanguard Total International Stock Index.

Meanwhile, Schwab also cut the fee on its large-cap foreign index tracker. Schwab International Index had not been a competitive alternative because of its 0.50% expense ratio. So, Schwab took action. In May 2009, it trimmed that cost to 0.19%.

In addition, Schwab has come out with other international index funds, such as Schwab Fundamental International Small Mid Company Index (SFILX). That one illustrates another trend in indexing: It veers away from the market-cap-weighted model of most international index funds, using screens to determine whether stocks make it into the portfolio and in what proportions.

ETFs
Over the past decade, the greatest amount of new international index funds have arrived in the exchange-traded realm. A large number of these focus on just one country or a handful of markets. But iShares and others (including Vanguard) have also come out with a wide variety of broader international indexing options in ETF form.

Some ETFs—both old and new—echo the choices available on the mutual-fund side, such as iShares MSCI EAFE (EFA) and SPDR S&P World ex-US (GWL). Others target narrower slices of the markets, such as iShares MSCI EAFE Value (EFV) and iShares MSCI EAFE Growth (EFG).

As noted, the ETF world also has a large number of offerings that target single countries, some of which are emerging or frontier markets, and some of which use leverage. The risks of such funds should be very well understood by anyone thinking of diving in.

In general, it’s better to have more choices than fewer. And lower costs are a clear benefit for investors. It’s important to remember, though, that along with broader choice comes complexity that takes more effort to understand.

And remember that not all index funds are great bargains. With both ETFs and mutual funds, don’t assume that an index ETF is necessarily dirt-cheap. There may be very similar alternatives that cost much less.