The Eqwitty Model ETFs (Part 2)
Yesterday we detailed, perhaps a little too detailed, the domestic portion of our model portfolios. Today we are going to cover the foreign and fixed-income portions.
iShares MSCI EAFE Index Fund (EFA)
If you weren’t quite full off of yesterday’s alphabet soup, here’s another serving. Morgan Stanley Capital International’s Europe Australasia Far East Index is a cap-weighted index that seeks to capture 85% of stocks in 21 countries, excluding the US and Canada. It is one of the most popular benchmarks in the investment industry for international investing.
With increasing globalization it would be foolish not to move some of your money to benefit from profits abroad. The MSCI EAFE has over 1000 constituents from 21 developed countries. To be clear, these are the 1000 largest firms across this set of countries, so this would be like the S&P 500 equivalent, except with more countries, and more companies. It makes up 15% of the Aggressive Portfolio and 10% of the Allocation Portfolio.
iShares FTSE Developed Small Cap (IFSM)
We have previously discussed the attractiveness of domestic small cap investments. It would only make sense that the same logic applies to smaller companies in other countries. The index is just as it sounds: it tracks 500 small cap companies you’ve never heard of (seriously) in 23 countries you have heard of outside of North America.
It has long been thought that small caps are riskier than their large cap counterparts and foreign companies are riskier than their domestic counterparts. With risk comes reward, but the key to asset allocation is balancing that risk and reward in case it becomes risk only. As such, IFSM makes up 5% of both of the model portfolios.
iShares MSCI Emerging Markets (EEM)
Let’s get exotic. Well, big spender, invest in EEM and at your next froufrou dinner function you can tell people you own a company in Prague and another in Columbia. Too bad when they dig deeper and find that you’re not a drug czar and all you did was invest in an ETF they might not be all that impressed. While the MSCI EAFE’s constituents are from 21 developED nations, the MSCI Emerging Market’s nearly 800 companies hail from 23 developING nations.
For 2008, the iShares MSCI Emerging Markets ETF boasted a negative 50.01% return. Clearly not for the faint of heart. But emerging markets have enjoyed much success over the last few years so much so that many called that the bubble would burst starting in 2007. How much success? Even after losing 50% of your money this year, had you invested in the index 10 years ago you would still have averaged a 9.02% annual return. Compare that with the -1.38% return of the S&P 500. Again, return and risk go hand in hand, and as such EEM is only allocated 5% in the Aggressive Portfolio and doesn’t even make the list on the Allocation side. This puts a little bit at risk if emerging markets somehow find more money to lose, but puts some money at work when emerging markets do recover.
iShares iBoxx $ High-Yield Corporate (HYG)
HYG has been previously highlighted here. Nobody knows when this current economic crisis will start to extinguish, but when it does we may see the equity like returns that high-yield bonds have previous shown.The bond markets are thought to follow an interest rate cycle and a credit cycle and many believe the worst of the credit cycle to be over. We do know that the cost of capital for companies has definitely increased, and as we make our way through the credit cycle the time will be ripe for investing in corporate bonds, especially high-yields.
Equity like returns with income to boot earns HYG a 10% allocation in the Aggressive Portfolio. A high-yield corporate bond, however, is still a bond and the Allocation Portfolio gives the iBoxx HY a full 15% for its expected equity and fixed-income characteristics.
iShares Barclays Capital Aggregate (AGG)
The Lehman Brothers US Aggregate Bond Index was the long standing fixed-income benchmark king. That is until Lehman went under shaking up not just the fixed-income markets, but equities as well. Great job, Dick Fuld! London-based global investment bank Barclays Capital, also owner of the iShares Funds, bought up the investment banking and trading business segments of Lehman, including the indices. Despite the new name, the Barclays Capital Aggregate is the same old dog with the same old tricks.
A faithful reliable dog, the bond index is used to track a broad base of investment grade bonds including Treasuries, Agency bonds, mortgage-backed bonds, and corporate bonds. Bonds are used by many investment managers and advisors to diversify risk away from equities (their returns are historically uncorrelated) and also to provide steady income payments. Bonds have average historical returns that are lower than equities, which makes cutting costs on investing in them that much more important. With the diversification and low expense ratio you get in the BarCap Agg ETF compared with the wild ride you may get with many actively managed bond portfolios, a 30% share to the Allocation Portfolio is a no-brainer.
So there you have it. The Eqwitty Model ETFs in all their glory and a little glimpse in to why they have been chosen. Keep in mind what we have said from the start and what is clearly stated in our site disclaimer. Investing involves risk and EVERY investor has her or his unique set of circumstances. Only you can know if you should be invested in any market.