Market-cap weighted international ETFs may not be in investors’ best interest, says First Trust’s Ryan Issakainen, who explains how his firm’s new products can give them more targeted country exposure.
Kate Stalter: Today, I’m speaking with Ryan Issakainen. He’s an ETF strategist at First Trust. Ryan, I understand that you have some insights into why investors should be looking at global markets these days.
Ryan Issakainen: Absolutely. I think one of the most important reasons why investors need to consider markets outside the US is, simply put, if you look at economic output, the US represents only about 19% or 20% of world GDP. So there’s opportunity overseas, and most investors, at least in the US, are by far underweight in international equities.
Kate Stalter: You just rolled out some new ETFs. Tell us about the focus of these, and what the objectives are.
Ryan Issakainen: Yeah, these are funds that are focused on individual countries, and it allows investors to get a little bit more targeted exposure if they want to, say, avoid countries and economies that are doing a lot of business with some of the European countries that are in some financial turmoil right now, and really want to focus on maybe some of the stronger countries in Europe, like Germany or Switzerland.
We thought there was a big opportunity in the international space, especially with specific countries, because a lot of the existing ETFs that focus on individual countries are market cap-weighted. The result of market cap weighting, when you’re looking at individual countries, is oftentimes a very top-heavy concentration in just a few holdings.
For example, one of the countries we like in the emerging markets is Brazil. We think there’s a very good long-term and even near-term investment case to be made for Brazil. But if you look at the MSCI index that the largest Brazil ETF follows, you have exposure to three companies that represent 40% of your overall portfolio. We think that’s too much stock-specific risk, and most investors are buying ETFs to diversify beyond that.
So our model in the First Trust AlphaDEX ETFs is to take a portfolio of stocks that’s selected, and then also weighted, according to investment merit instead of size. We think that’s an approach that avoids some of that stock-specific risk, because your portfolio is more evenly distributed, yet it is overweight in the stocks that have better valuations and overall better investment merit, in our opinion.
Kate Stalter: Very interesting approach. Can you give us a quick rundown of what the new ETFs are, and their tickers?
Ryan Issakainen: There are nine ETFs, seven of which are focused on individual countries, and the other two are small-cap. One is in the emerging markets and one is in the developed markets.
The ticker symbols that coincide…let me just sort of read through them with you: The first one is our Australia Fund (FAUS). The second is our Canada Fund (FCAN). After that is Germany (FGM), Hong Kong (FHK), Switzerland (FSZ), Taiwan (FTW), United Kingdom (FKU).
And then those two small-cap funds: In the Emerging Markets (FEMS), and in the Developed Markets (FDTS). So, that’s the rundown of the ticker symbols in those ETFs that began trading last week.
Kate Stalter: Just to wrap up today, Ryan, how would you suggest that retail investors incorporate some of these into their existing portfolio?
Ryan Issakainen: Well, I think they need to look at what their overall asset mix is today, and really see if they are getting exposure to international stocks. Some investors are, just because of the multinational stocks in their domestic portfolio.
There’s a lot of companies that do business and even some that are based in the US that do the majority of their business overseas. But I would suggest that most investors are probably underweight in some of the companies in the countries that are doing business more within those particular economies.
Again, turning back to Brazil, I would suggest that some of the medium-sized companies in Brazil that do more business within Brazil and the Latin America area are probably under-represented. So they need to consult, perhaps, with a financial advisor who can take a look at their overall risk that they’re willing to take, and the level of returns that they’re seeking, and really see how they can go the optimal asset-allocation model that matches their risk and reward.
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