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ETF Specialist

Older Doesn't Mean Better

There are broader, cheaper options than this 2000-era world-stock ETF.

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 IShares Global 100 (IOO) offers exposure to the 100 largest multinational, blue-chip companies in the world, including names such as  Apple (AAPL),  Nestle (NSRGY),  HSBC (HSBC), and  Toyota (TM). This fund is suitable for use as a core holding, but given its approximately 60% allocation in U.S. large caps, it may overlap significantly with most investors' existing holdings.

Launched in 2000, this was one of the first exchange-traded funds to provide exposure to a portfolio of equities from around the world. Its benchmark was designed to be investable and easy for index funds to replicate, hence the mega-cap focus. Since then, it has become a lot easier for global-equity index funds to provide exposure further down the market-cap spectrum, as foreign markets grow more liquid and as indexing strategies become more popular.

This mega-cap fund has a portfolio average market cap of $140 billion, one of the largest among all ETFs listed in the United States. This is about 2 times the size of the average market cap of the S&P 500. IOO has exhibited similar levels of volatility to the S&P Global 1200 Index (a broader index composed of 1,200 of the largest global firms) during the trailing 15-, 10-, and five-year periods. However, the S&P Global 1200 Index has outperformed over each of these periods, thanks to its broader portfolio, which includes mega-cap and large-cap firms, and a small allocation to emerging-markets stocks. Investors may want to consider global-equity funds with a broader portfolio than IOO. In addition, many of the other cap-weighted, global-equity ETF options are cheaper than IOO, which charges an annual expense ratio of 0.40%.

This fund is in the world-stock Morningstar Category. Most funds in this category are either core allocation building blocks (primarily ETFs composed of thousands of securities) or global best-ideas funds (primarily actively managed funds comprising around 100 holdings). As a result, the funds in this category can have somewhat different country allocations. This fund has a 60% weighting in U.S. stocks (versus the category average of 50%) and a 0% weighting in emerging-markets stocks (versus the category average of 7%).

Fundamental View
This fund is dominated by blue-chip multinationals, which during the past few years have benefited from improving productivity, cheap financing, and exposure to faster-growing emerging markets. Most of these firms are in good financial shape. However, now that the U.S. Federal Reserve's quantitative-easing program has ended, there is uncertainty as to how monetary policy will be managed and how it might ultimately affect global asset prices--especially considering that valuations across most major asset classes appear to be somewhat stretched.

In Europe, the macroeconomic environment continues to be weak, with near-zero gross domestic product growth, 10%-plus unemployment, deflationary pressures, and ongoing deleveraging in the banking sector. At this time, the European Central Bank is doing whatever it can to preserve the European Union and prevent the eurozone from going into a deflationary spiral. During the past few years, European equities, as measured by the MSCI Europe Index, have recovered from 2012 lows. However, this rally was muted for investors in this fund in 2014 and 2015 because of the falling euro against the U.S. dollar. The MSCI Europe Index, in local currencies, returned 4.7% and 4.9% in 2014 and 2015, respectively, whereas in U.S. dollar terms, the returns were negative 6.2% and negative 2.8%.

After two "lost decades," Japan's equity markets responded very enthusiastically to Prime Minister Shinzo Abe's programs to jump-start the Japanese economy. At the start of 2013, Japan's Central Bank unleashed an aggressive monetary-easing program. This move provided the foundation for improving macroeconomic fundamentals and corporate earnings growth. Dividend payout ratios and buybacks are on the rise, as are returns on equity. Japanese equities may also benefit as Japan's $1.2 trillion public pension raises allocations in domestic equities and away from low-yielding government bonds. However, any sustainable economic growth in Japan will require structural reforms to address Japan's inefficient labor market and protected private sector. These issues have long been on lawmakers' agendas, and there has been little progress or improvement on these fronts during the past two decades because of strong, entrenched interests.

This fund does not hedge its currency exposure, so its returns reflect both asset price changes and changes in exchange rates between the U.S. dollar and other currencies. In theory, the returns of a hedged and unhedged portfolio of developed-markets stocks should be almost the same over the long term. This is because the euro, the Japanese yen, and the British pound (which accounts for about 30% of the fund's foreign-currency exposure) are free-floating currencies, which, over the long term, should adjust to reflect differences in real interest rates between the two countries. In other words, the difference in interest rates between two countries is ultimately reflected in the difference in exchange rates, so currency movements should have only a negligible impact on a portfolio's returns. However, in the short term, currencies can trend away from their fundamental value, sometimes for many years. As a result, the relative performance of a hedged portfolio versus an unhedged portfolio is very time-specific.

Portfolio Construction
This ETF employs full replication to track the float-adjusted, market-cap-weighted S&P Global 100 Index. The 100 constituents of this index have operations that are global in nature with a substantial portion of their operating income, assets, and employees from multiple countries. In addition, the index's sector weightings attempt to mirror those of the broader S&P Global 1200 Index. An S&P index committee oversees this index and may make some adjustments based on qualitative factors during the annual rebalance. Notable recent additions to the index include Apple and  Alphabet (GOOG). This fund's foreign-currency exposures are the euro (17% of the portfolio), the British pound (10%), the Swiss franc (6%), and the Japanese yen (5%).

Fees
The fund charges an annual expense ratio of 0.40%, which is high for a fund that holds 100 very liquid stocks. During the past three years, the fund outperformed its benchmark by 14 basis points annualized. This is mostly attributable to the fact that the fund's benchmark incorporates aggressive foreign tax-withholding assumptions. In practice, the fund has had lower foreign tax withholding relative to the estimates incorporated in its benchmark.

Alternatives
A solid core allocation option is  Vanguard Total World Stock (VT). This fund tracks the FTSE Global All Cap Index, which seeks to cover 98% of the world's total investable stock market capitalization and includes approximately 7,500 securities. It has a low expense ratio of 0.14%.

Another passive, but non-cap-weighted, option is  iShares Edge MSCI Minimum Volatility Global (ACWV). This fund tracks an index that attempts to create a portfolio of stocks culled from the MSCI All Country World Index that has the lowest absolute volatility with a given set of constraints to maintain country and sector diversification. Low-volatility strategies seek to exploit the observed phenomenon that portfolios with smaller price fluctuations tend to outperform portfolios with larger price fluctuations over the long term. This ETF charges 0.20%.

For a list of Morningstar Medalists in the world-stock category, please click here.

 

 

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Patricia Oey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.