Don't Let the Label Lead You Astray

 | Apr 20, 2012 | 11:00 AM EDT
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Perhaps one of the greatest contributions of ETFs over the last several years is simplicity. The surge in popularity of exchange-traded products has dramatically simplified the business of investing, making it easy for individuals to achieve access to asset classes and strategies that were once beyond their grasp. It's now possible even for amateur investors to build a cheap, diversified, low-maintenance portfolio with only a handful of ETFs.

But sometimes, the level of simplicity offered by ETFs is misleading. When building a long-term, buy-and-hold portfolio, it's often tempting to use "global" ETFs as building blocks that offer one-stop exposure to the world stock and bond markets, instead of taking a piecemeal approach that involves cobbling together various regions of the world in customized weightings.

The appeal of such "one-stop shops" is understandable. Many investors like to keep the portfolio construction process as simplified as possible, and getting the entirety of your equity exposure through a single ticker is about as simple as it gets. But these products are often not truly globally diversified, and they often feature relatively significant concentrations and disconnects from economic reality.

Take the MSCI All Country World Index Fund (ACWI), which has about $2.7 billion in assets. ACWI includes exposure to more than two dozen economies, including developed and emerging markets in just about every corner of the globe. But there's a heavy tilt toward advanced economies in general, and to the U.S. in particular. Excluding the quasi-developed markets of South Korea and Taiwan, ACWI makes an allocation of only about 10% to emerging markets. China, the world's second-largest economy, makes up just about 2% of assets. That puts it behind the U.K., France, Germany and even Switzerland, in terms of country allocations.

If ACWI is underweighted to emerging markets, it is overweighted to the U.S., which makes up about 45% of the portfolio. That breakdown is far from consistent with the relative sizes of the economies represented. The result is a portfolio that may technically be global, but is more accurately described as a U.S.-plus-Western-Europe ETF (with a smattering of Asian and emerging economies).

For some investors, the allocation provided by ACWI might be appropriate and desirable. But for many with a long-term focus, the dramatic underweighting of emerging markets could be a bit of a problem. I don't need to remind you where the majority of global gross domestic product growth is coming from nowadays, so such a small weighting to such countries such as China and India seems like a less-than-optimal strategy to me.

Another example of a not-so-global ETF is the recently launched iShares Global High Yield Corporate Bond ETF (GHYG). Though GHYG includes exposure to junk bonds from more than a dozen different countries, it's anything but global. For starters, GHYG focuses only on developed markets, and specifically on those in North America and Europe (there's no exposure to Japan or Australia). Moreover, the U.S. accounts for about 70% of the portfolio, with the relatively small remainder spread across a host of Western Europe economies.

The lesson here, as is often the case, is that it's never a good idea to judge an ETF by its cover. Names can be misleading, but the contents of an exchange-traded product will never lie. ETFs are completely transparent, so take advantage of that feature and do your research before jumping into a position.


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