Defensive exposure to international stocks

This low-volatility ETF should give investors in overseas stocks a smoother ride and better downside protection.

Alex Bryan 14 June, 2016 | 5:00PM

Currency fluctuations tend to make foreign stocks more volatile than their Canadian counterparts. Currency hedging is a potential solution, but it can increase transaction costs and reduce tax efficiency. As an alternative, investors might consider a defensive international-equity strategy, like iShares Edge MSCI Minimum Volatility EAFE (XMI).

This exchange-traded fund holds units of its  U.S.-listed counterpart (EFAV), which employs full replication to track the MSCI EAFE Minimum Volatility Index. It attempts to create the least-volatile portfolio possible with large- and mid-cap stocks listed in developed markets in Europe, Australia and Asia, under a set of constraints. These include limiting sector and country tilts relative to the MSCI EAFE Index, which improves diversification. The fund doesn't just target the least-volatile stocks. It takes into account each stock's exposure to common risk factors and the covariances among them to better estimate how the holdings will contribute to the portfolio's overall volatility. This may be a suitable core holding for conservative stock investors.

The fund will likely offer a more favourable risk/reward trade-off than the broad market-cap-weighted MSCI EAFE Index. But because it is taking less risk, this won't necessarily translate into better returns. Investors should expect the fund to lag the MSCI EAFE Index during market rallies, hold up better during market downturns, and offer similar returns -- or slightly less -- over the long term.

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About Author

Alex Bryan

Alex Bryan  Alex Bryan, CFA, is director of passive strategies for North America at Morningstar. Before assuming his current role in 2016, he spent four years as an analyst covering equity strategies. He holds an MBA with high honors from the University of Chicago Booth School of Business.

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