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Summary EFA is a mediocre ETF. The sector allocation is mediocre, the geographic diversification is mediocre and the expense ratio is mediocre. The top holdings make sense, but they don’t reflect the total portfolio. Despite having a heavy portfolio weight towards financials, there is only one in the top ten. There is nothing bad about the ETF to warrant taking a capital gains tax on sale, but if a loss could be taken with proceeds reallocated… that would be nice. There isn’t much to say to make this ETF sound exciting. There are so many international ETFs it can be difficult for investors to choose one. Hopefully I can help with that problem by highlighting some of them and shining a light inside their portfolio. One of the funds that I’m considering is the iShares MSCI EAFE ETF (NYSEARCA: EFA ). I’ll be performing a substantial portion of my analysis along the lines of modern portfolio theory, so my goal is to find ways to minimize costs while achieving diversification to reduce my risk level. Expense Ratio The expense ratio on the iShares MSCI EAFE ETF is .33%. I’d really prefer to see lower, but that isn’t high enough to remove the ETF from being worthy of further consideration. Geography The map above shows the top 10 countries by the market value of their allocations. This is certainly an international ETF, but the holdings seem more diversified from the list on the left side than from the list on the right side. I’d like to see even more diversification, but at least they have not assigned any single country a weighting higher than 25%. Sector Looking at the sector allocation is fairly interesting. Fortunately this is a fairly diversified group of sectors, but I think I would prefer a smaller allocation to financials. Perhaps I’m being too picky, but I’d rather see more consumer staples and foreign utilities mixed into the portfolio. I’d like to have the benefits of international diversification while overweighting the sectors that I expect to be less volatile. Largest Holdings (click to enlarge) Looking at the individual holdings, you wouldn’t expect that “Financials” would be so overweight. Only one financial company is in the top 10. The concern for me is that a heavy focus on financials in the lower parts of the portfolio suggests to me that the ETF may have a heavier weight on the companies that are easier to research or buy if markets are not sufficiently liquid in some countries. Building the Portfolio The sample portfolio I ran for this assessment is one that came out feeling a bit awkward. I’ve had some requests to include biotechnology ETFs and I decided it would be wise to also include a the related field of health care for a comparison. Since I wanted to create quite a bit of diversification, I put in 9 ETFs plus the S&P 500. The resulting portfolio is one that I think turned out to be too risky for most investors and certainly too risky for older investors. Despite that weakness, I opted to go with highlighting these ETFs in this manner because I think it is useful to show investors what it looks like when the allocations result in a suboptimal allocation. The weightings for each ETF in the portfolio are a simple 10% which results in 20% of the portfolio going to the combined Health Care and Biotechnology sectors. Outside of that we have one spot each for REITs, high yield bonds, TIPS, emerging market consumer staples, domestic consumer staples, foreign large capitalization firms, and long term bonds. The first thing I want to point out about these allocations are that for any older investor, running only 30% in bonds with 10% of that being high yield bonds is putting yourself in a fairly dangerous position. I will be highlighting the individual ETFs, but I would not endorse this portfolio as a whole. The portfolio assumes frequent rebalancing which would be a problem for short term trading outside of tax advantaged accounts unless the investor was going to rebalance by adding to their positions on a regular basis and allocating the majority of the capital towards whichever portions of the portfolio had been underperforming recently. Because a substantial portion of the yield from this portfolio comes from REITs and interest, I would favor this portfolio as a tax exempt strategy even if the investor was frequently rebalancing by adding new capital. The portfolio allocations can be seen below along with the dividend yields from each investment. Name Ticker Portfolio Weight Yield SPDR S&P 500 Trust ETF SPY 10.00% 2.11% Health Care Select Sect SPDR ETF XLV 10.00% 1.40% SPDR Biotech ETF XBI 10.00% 1.54% iShares U.S. Real Estate ETF IYR 10.00% 3.83% PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB 10.00% 4.51% FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT 10.00% 0.16% EGShares Emerging Markets Consumer ETF ECON 10.00% 1.34% Fidelity MSCI Consumer Staples Index ETF FSTA 10.00% 2.99% iShares MSCI EAFE ETF EFA 10.00% 2.89% Vanguard Long-Term Bond ETF BLV 10.00% 4.02% Portfolio 100.00% 2.48% The next chart shows the annualized volatility and beta of the portfolio since October of 2013. (click to enlarge) Risk Contribution The risk contribution category demonstrates the amount of the portfolio’s volatility that can be attributed to that position. You can see immediately since this is a simple “equal weight” portfolio that XBI is by far the most risky ETF from the perspective of what it does to the portfolio’s volatility. You can also see that BLV has a negative total risk impact on the portfolio. When you see negative risk contributions in this kind of assessment it generally means that there will be significantly negative correlations with other asset classes in the portfolio. The position in TDTT is also unique for having a risk contribution of almost nothing. Unfortunately, it also provides a weak yield and weak return with little opportunity for that to change unless yields on TIPS improve substantially. If that happened, it would create a significant loss before the position would start generating meaningful levels of income. A quick rundown of the portfolio I put together the following chart that really simplifies the role of each investment: Name Ticker Role in Portfolio SPDR S&P 500 Trust ETF SPY Core of Portfolio Health Care Select Sect SPDR ETF XLV Hedge Risk of Higher Costs SPDR Biotech ETF XBI Increase Expected Return iShares U.S. Real Estate ETF IYR Diversify Domestic Risk PowerShares Fundamental High Yield Corporate Bond Portfolio ETF PHB Strong Yields on Bond Investments FlexShares iBoxx 3-Year Target Duration TIPS Index ETF TDTT Very Low Volatility EGShares Emerging Markets Consumer ETF ECON Enhance Foreign Exposure Fidelity MSCI Consumer Staples Index ETF FSTA Reduce Portfolio Risk iShares MSCI EAFE ETF EFA Enhance Foreign Exposure Vanguard Long-Term Bond ETF BLV Negative Correlation, Strong Yield Correlation The chart below shows the correlation of each ETF with each other ETF in the portfolio. Blue boxes indicate positive correlations and tan box indicate negative correlations. Generally speaking lower levels of correlation are highly desirable and high levels of correlation substantially reduce the benefits from diversification. (click to enlarge) Conclusion EFA certainly has some volatility, but the correlation over longer time periods has been significantly lower than the correlation levels created by measuring on a daily basis. All around, this is a decent but not spectacular ETF. The ETF has a respectable but not incredible diversification among countries. The holdings are concentrated on the financial sector, but only one financial firm was able to warrant a large enough allocation to end up in the top 10. When it comes down to the sheer volume of holdings, there are 934 companies in the portfolio. Of course, that could change at any point. I love having extreme levels of diversification like that in international equity allocations, but such high diversification indicates a passive indexing strategy. As you might imagine, I’d rather not pay the .33% expense ratio for a passive index fund. The problems within the ETF aren’t bad enough for investors to have any cause to sell it and incur a capital gains tax, but I’d rather place international equity allocations in other ETFs. If an investor is able to harvest a tax loss on selling, that would be a very solid reason to reallocate to a more appealing ETF. If you’re looking for more appealing options, I put together an article with three of them . Scalper1 News
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