Global ETF Investing Strategies (EFA, EWJ, EWU, EWS, EWH, SCJ)

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August 5, 2010 2:32pm NYSE:EFA NYSE:EWH

No hunter worth his salt would try to nail a trophy bighorn with a shotgun. It would be equally foolish to try bagging a prize turkey with a rifle shot. The same thinking applies when you’re going after stocks. You have to use the right investment tools to fit your strategy. It sounds simple, but you’d be

 surprised by how many global portfolios I’ve reviewed over the years that are a mish-mash of stocks and mutual funds, dumped in there with little rhyme or reason.

So when you’re executing a global investment strategy, do you take a broader view (the “shotgun” approach) or try to nail down your investments more specifically (the “rifle” approach)?

I’m going to show you why you should put both weapons in your arsenal. Think of it as big-game hunting… Wall Street style…

When You Should Use the “Shotgun” Approach

Let’s break down both approaches, so you know how to use each one to best effect…

The Shotgun Approach
Over the past few years, exchange-traded funds (ETFs) have exploded in popularity. There are now over 1,000 ETFs trading on the U.S. markets, covering just about every asset class you can think of – junior gold miners, coffee, Turkey, emerging market bonds, the Chinese yuan. The list goes on.

ETFs are baskets of stocks that are normally weighted by a company’s market value. The advantages of ETFs over actively managed mutual funds are clear…

  • Lower costs and taxes.
  • Greater buying/selling flexibility because ETFs trade just like regular stocks.
  • Greater transparency because you can see the holdings in each ETF.
    ETFs are one of the fastest-growing investment tools on Wall Street and because of their broad-based approach (be it to a region, sector, industry or commodity), it’s akin to giving an investor a shotgun to get that all-encompassing exposure.

For an example of the shotgun approach, let’s take the iShares MSCI Europe, Australia and Far East ETF (NYSE: EFA). This is one of the most popular ETFs on the market for investors looking to get diversified exposure to 21 developed international markets.

But there’s a problem…

One key to successfully investing in ETFs is to “look under the hood” to see what stocks an ETF holds and how the fund is weighted. You’ll often be quite surprised.

With EFA, for example, you might think you’re gaining broad diversification in many international markets. But a closer inspection reveals that roughly 44% of your money would go to Japan and the United Kingdom, while only 2% to dynamic markets like Singapore and Hong Kong.

Use the Rifle Approach to Become a Stock Sniper

This is where the rifle approach comes into play…

The Rifle Approach
Let’s face it… while a basket of stocks in an ETF gives you valuable diversification for less risk, it comes at the cost of limiting your upside.

For example, Indonesia was a terrific choice in 2009, as its market rocketed more than 100% but you’re just not going to have a prized 10-bagger with an Indonesian ETF.

It’s also why I always bypass ETFs like EFA and decide for myself how much I want to invest in any market like Japan (NYSE:EWJ), the United Kingdom (NYSE:EWU), Singapore (NYSE:EWS) or Hong Kong (NYSE:EWH).

To take it a step further, if you believe in Japan’s comeback, you might prefer to invest in a basket of smaller Japanese companies that are collectively trading below their book value – for example, the iShares MSCI Japan Small Cap Index (NYSE: SCJ).

So why not couple an ETF approach (shotgun) with one or more individual stock picks (rifle) and give yourself a shot at the best of both worlds?

Pack a Shotgun… And a Rifle

For example, if the Japanese yen were to weaken, the export-laden iShares MSCI Japan Index (NYSE: EWJ) should do very well indeed. But coupling this with one good undervalued and unappreciated Japanese stock pick could supercharge your returns.

Likewise, if you dig around in the small-cap SCJ, you could pull out a fast-growing healthcare services company seeking to exploit Japan’s aging society.

Blending a broad ETF approach with some sharpshooter stock picks will inject more organization and flexibility into your global portfolio, since you can decide what blend of ETFs and stock picks fits your personal situation.

Good investing,

by Carl Delfeld, Contributing Editor

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