The Big Picture for the Week of January 23, 2011

Joseph Shaefer had a post up at Seeking Alpha on foreign investing that offered a lousy acronym (sorry Joe) but a great discussion topic for building the developed-foreign part of an equity portfolio. To read the article he favors Australia, Switzerland, Norway, Britain, Singapore, Canada, New Zealand and Sweden. I generally agree but am less sanguine on Britain and would add Denmark and Israel to the list.

While I have said a few times that I think terms like emerging and developed are losing their utility, that is the context of Joseph's post so I will stick with them for today.

All of Joseph's country picks have ETFs available which makes the concept precisely accessible for people who would rather not pick individual stocks. For Australia there is the iShares Australia ETF (EWA) and IndexIQ Australia Small Cap (KROO), iShares Swizterland (EWL), Global X Norway (NORW), iShares United Kingdom (EWU), iShares Singapore (EWS), for Canada there is iShares Canada (EWC) and IndexIQ Canada Small Cap (CNDA), iShares New Zealand (ENZL) and iShares Sweden (EWD). EWA is a personal holding and a few clients own it.

The biggest concern with building a portfolio of country funds (the assumption is that the countries have been researched and a decision to buy has been made) would be that the sector mix creates an enormous overweight or an extreme underweight. In this instance all that is required is a little spreadsheet work assuming a simplistic weighting of the funds. We benchmark to the S&P 500 so the sector weights in the SPX will serve as the benchmark for this post.

There are eight countries and ten ETFs (two ETFs for Canada and two for Australia). I did the work on two versions. One where I used the large cap iShares funds for Australia and Canada and one where I used the IndexIQ small cap funds for those countries. In the version with the two large cap funds the biggest overweights are in financials and materials. The largest underweights were tech, healthcare and the two consumer sectors. The rest were reasonably close. In the version with the small cap funds the financial exposure came down to be inline with the SPX and materials increased into a larger overweight, the changes in the other sectors only being slight.

I was surprised that there were not more extreme sector variances. Of most interest was the materials sector. The way I built the two versions materials were 11.3% in the large cap version and 15.1 in the small cap version versus 3.58% for the S&P 500. In looking at the list of countries obviously several of them are commodity based including the UK by virtue mega cap companies like BHP Billiton which is cross listed which is 15% in materials. Anyone interested in taking on a double digit weight in materials stocks (or funds) needs to assume that they are taking on more volatility (most true even if there are some materials stocks with low volatility) than the S&P 500 which is neither bad nor good, it just is. Clearly some investors would be just fine with a more volatile portfolio but it is important to understand the characteristic of the sector--well that applies to every sector doesn't it?

The idea of simply implementing someone else's work is a very bad idea but reading Joseph's article is time well spent in terms of what leads him to his conclusions and as I own many of the countries he isolated I'm on board with most of it. Obviously "emerging" markets have a role in a diversified portfolio (I don't think he is saying otherwise) for someone with a normal tolerance for volatility along with themes and at least a few domestic stocks.