If you want to capture exposure to international equities in just one ETF, what should it be? Here, I tested contenders VXUS, ACWX and DFAX and found DFAX the best for gaining broad exposure across the globe and market caps and totally worth its slightly higher expense ratio.
In the past, I usually did these reviews of the assets in the test portfolios in a presentation format: here is what I use to invest in commodities, this for long-term bonds, etc. But starting with my re-evaluation of small-cap value, I found the asset reviews most productive if framed as a quest to figure out which is best -- dispense with the assumptions, set the criteria, examine the data, and make the call.
This time: which ETF is best for a risk parity portfolio if you want international equity exposure in just one fund?
To take a step back - why international equities in the first place? It’s not a slam dunk, as US equities have outpaced ex-US equities substantially since the GFC: 10.7% CAGR for the American total stock market ETF (VTI) compared to 2% for the one excluding the US (VXUS). International stocks also don’t add much in the way of diversification (details below), since correlation numbers are typically in the high .8s and low .9s. They will not save you in a general market downturn; the geographic location of company headquarters matters little, all things considered.
Still, the logic behind holding international equities is the same as the logic behind index investing as opposed to selecting individual stocks. I want to avoid making specific bets on particular assets in favor of general exposure to the market as a whole, and this applies equally to avoiding specific bets on specific national stock markets. For most decades, international equities and US equities have kept pace with one another, and it was really just the last decade or so in which the US pulled ahead. Mab Faber has the best resource for pulling together all the threads of why international investing should be a part of your portfolio.
Meb Faber
You may also like this episode of the Meb Faber show which presents the case for international equities.
If you decide to have both a US and a non-US allocation in your equities, the question remains how much of each. Faber says to start with a 50/50 split, and that seems fine and the easiest to track. If you are interested in adhering to their actual percentages by market cap, it would be 60% US/40% ex-US. The Vanguard Total Global Stock Market fund has basically the same breakdown, with emerging market funds as 10.4% of the world’s total. If it's not otherwise onerous, I'd go with 3:2, but 1:1 is fine too.
How Will I Decide?
What exactly am I looking for in this one fund for exposure to international equities?
- I want as much coverage of the entire realm of equities outside of the United States, so I’m looking for a high number of holdings and not exclusively large-cap. This criterion eliminates a number of attractive ETFs with exposure to large-caps only.
- Likewise, the fund should have an allocation to equities from emerging markets, not just developed market equities, to ensure broad geographic coverage. This step takes a number of funds out of the running as well, as many fund providers treat EM as a separate asset class. In the end, the hunt is on for an international fund covering all market caps and all countries.
- As usual, my preference is for low fees, all else being equal, with an acknowledgement that departing from market-cap weighting brings with it higher costs. Those costs may be worth it, however, so I’ll consider systematic approaches even with higher management fees, as long as the fees can be justified by a more sophisticated investing approach.
Typically, correlation is a central concern for investment choices for a risk parity portfolio, but that is on the back burner for this analysis since I really don’t expect much diversification with international equities. With these I am pursuing variety, not necessarily dissimilarity (there’s a difference!), within the equity sleeve to ensure I’m capturing as much of the equity market as possible. In case you’re curious, though: VXUS and ACWX had correlations in the low .9s compared to VTI, VUG and VIOV. DFAX was in the high .8s, but only dating back to October, 2021. In other words, there is only a minimal diversification benefit to holding international equities along with US equities.
The Candidates
VXUS
Vanguard Total International Stock ETF. Fund page, Barchart Summary. This is the most obvious in the space: very straight-forward, very large, very liquid, and very vanilla. Tracks the FTSE Global All Cap ex US Index.
ACWX
iShares MSCI ACWI ex U.S. ETF. Fund page, Barchart Summary. Not a whole lot different than VXUS in intent, though it does track a different index, the MSCI ACWI ex USA Index. This is the same as DFAX below, so it makes for a nice comparison with the other two competitors.
DFAX
DFA World ex-US Core Equity 2 ETF. Fund page, Barchart Summary. This is the ETF converted from the mutual fund DFTWX, which was started back in 2008. DFA also has a similarly-named fund, DFAI, but that one is different in being developed markets only. Not a passive index fund, but it is a highly systematic fund that tracks the MSCI ACWI ex USA Index, differing mainly from ACWX in departing from pure market-cap weighting. Their exact method is not public, but according to the prospectus, DFAX pursues “increased exposure to smaller capitalization, lower relative price, and higher profitability companies as compared to their representation in the Non-U.S. Universe.”
First Criterion: All Market-Caps
These are fairly straight-forward tests to run using data from the Fund Performance tool on Portfolio Visualizer:
Of these, ACWX is the most large-cap heavy and with no small-cap allocation whatsoever, it’s not great. I would assume the VXUS allocations are consistent with their proportional weights in real life, so if you’re looking for straight weighting by market cap only, then VXUS would be fine. Clearly, though, DFAX is attractive due to its tilting towards smaller cap stocks with higher expected return in the long term.
Second Criterion: All World
Easy to find using data from the funds themselves (with pages linked below):
These are all in the same ballpark, with slight variations in each. Interestingly, I had to move some things around in terms of the definition of an emerging market. South Korea and Taiwan are considered part of the Pacific category by ACWX, but in the emerging market category according to DFAX. Meanwhile, though I can’t see exactly how VXUS treats either country, a little bit of math leads me to guess that Taiwan is grouped as an emerging market but Korea is considered part of developed Asia. To get an apples-to-apples comparison, I changed the calculation of DFAX to make it similar to the way ACWX treats those two countries. I then changed VXUS to include Taiwan under developed Asia, along with South Korea. There may be other countries to which this applies, but those are the two that are significant enough to make a real change in the data.
You get total world coverage with all three, and all have roughly the same breakdowns by region. I would bet the slight differences between regions and with emerging markets are as much about how the different countries are classified as much as they are conscious choices to emphasize one country’s equities over another’s. I don’t really think there is a “winner” for this criterion; all three meet the criteria for being a total world fund.
Third Criterion: Fees and Performance
All three are low-fee funds, though VXUS is clearly the cheapest, with an expense ratio of .07% compared to .32% for ACWX and .31% for DFAX. As I explained in another post, I’ve relented on my previous pattern of always choosing the fund with the lowest fees. This was an issue when comparing index funds around .2% with actively managed mutual funds at ten times that, but is not such a big deal when even the “expensive” funds are at .31%. It does, however, make me wonder what the real draw is for ACWX. It doesn’t do anything beyond what VXUS does, but costs four times as much.
DFAX is a different story. You’re paying more in fees, but theoretically getting something for that: a fund that emphasizes known factors that provide better long-term returns regarding size, value, and profitability. You can see it with the factor regression for the fund: DFAX provides more exposure for all three factors. Do keep in mind, though, that DFAX dates back to just October 2021, rendering the data from backtests very limited, even though Dimensional did have a predecessor mutual fund with the same approach (DFTWX).
The limited timeframe frustrates other measures of performance, as well. The twelve months or so of DFAX’s existence have been bad ones for the market and for international equities, so the various looks at DFAX’s performance all show significant declines. Here is a basic look, using Portfolio Visualizer’s Fund Performance tool:
Again, there really isn’t enough data to draw any conclusions from. Over the past year, DFAX has been slightly less terrible than the others, but still bad. The longer time frame without DFAX, meanwhile, has me questioning why I might want to invest internationally anyway. Both VXUS and ACWX have lagged behind US equity funds, though this does not guarantee that this pattern will continue. If anything, international funds might just be more competitively priced.
So…What’s the Preferred Asset for International Equities?
As for a verdict, it looks to me like DFAX has the better evidence behind it, if you are looking for an all-in-one ETF for international equities. It checks all the boxes: covers all market caps, covers the globe, gives you slight factor exposure, and isn’t too expensive. It doesn’t have much of a track record, but the fund family certainly does. VXUS seems fine, too, if you just want straight-up market cap weighting at the lowest cost. ACWX feels a bit like a fund without a country - more expensive than the equally passive VXUS, not as sophisticated as DFAX at the same expense point.
If you want to open the international equity box up a bit, and contemplate the use of several ETFs to compose your international strategy, then the calculus may change somewhat. Perhaps VXUS is your overall fund for international exposure, and then you could supplement it with AVDV, the international small-cap value fund from Avantis. I love their US version, AVUV, so much and would bet that AVDV would fare well in a comparison. Another direction to go in could be DISV from Dimensional. If you want to focus more on emerging funds, then AVEM or AVES from Avantis could complement VXUS. If you want to stay in the world of passive low-cost funds, then you could split your global equities between VEA, a developed markets large-cap, VSS, a developed markets small-cap, and VWO, an emerging markets fund, all from Vanguard and all with rock bottom expense ratios.
Having multiple funds in your international equity group has some appeal and might offer you some rebalancing premium as you buy the piece with the lowest price at a given time. There are diminishing returns with that though, and I wonder if, after all of that research and the trouble of tracking a few more funds, that you just wind up recreating DFAX anyway.