ITA Wealth Management

One of the Premium Content clients pointed out an important point when it comes to selecting VEU as the international ETF. VEU is holding 21.7% in emerging markets as it tracks the FTSE All-World ex. U.S. Index, whereas the iShares ETF, EFA, tracks the MSCI.

The question raised was one of style drift. If we assign a target percentage to be invested in developed international countries, are we being true to our target by investing in VEU where nearly one quarter of the investments are actually invested in emerging markets. The blunt answer is, no.

One of the primary reasons we are using VEU over EFA is the expense ratio. VEU charges 25 basis points while the cost to hold EFA is 34 basis points. Right now we are not paying a performance penalty by holding VEU as it is doing better than EFA over nearly every period one can test. The reason is the better performing emerging market.

There are at least two ways to solve this issue. 1) Eliminate emerging markets from the portfolio and let an investment in VEU cover both developed and developing countries. 2) Increase the ratio between VEU and VWO taking into account that VEU is investing between 20% and 25% in emerging markets.

Since there is no perfect portfolio allocation of assets, style drifts such as this one with VEU sometimes works to our benefit and sometimes becomes a disadvantage.  This does not mean we should neglect the problem.  Just beware that it does exist.

Lowell Herr

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