New ETFs Put World in Investors' Hands

Investors — at least the smart ones — spend a lot of time trying to anticipate those shifts. After all, numerous studies have shown that asset allocation is a major determinant of a portfolio's returns. But with foreign markets multiplying and becoming increasingly complex, creating an effective asset-allocation strategy that includes points across the globe is tough even for seasoned pros.

The exchange-traded-fund industry thinks it has an easy solution to that difficult task. Several ETFs have been launched or are in registration with the SEC that offer investors exposure to the world's largest companies. The underlying principle is simple: Alleviate investors from making asset-allocation mistakes by giving them instant diversification among the best names in the U.S., Europe, Asia and dozens of other countries at a reasonable price.

The idea, though, isn't without controversy. A one-size-fits-all approach can be very appealing to conservative investors or those who just don't have the time to study the thousands of ETFs and mutual funds that are on the market. All they need to do is buy the fund, sit back and relax. Over the long term, the thinking goes, these funds will sit at the center of a given portfolio and provide a tidy average return.

The problem is that these new ETFs follow static indexes that, more or less, will always own the same countries, sectors and stocks. That means investors can't pick and choose the spots they want to avoid or own. For example, most international ETFs have exposure to Switzerland's banking industry. But what if you thought, for some reason, that those stocks were going to drop in value over the next 12 months? In that case, you're stuck hoping your prognosis doesn't materialize.

"For passive investors [these funds] are a low-cost way to get world-wide diversification. That's a big advantage," says Frank Beck, owner of Capital Financial Investment Group in Austin, Texas. But, he warns, as the globe grows closely intertwined, it's becoming more important to pick the right sectors and countries. "We shed home builders and then shed mortgage companies and then finally the banks. It didn't take a crystal ball to realize all that." Index investors, he says, wouldn't have been able to pull off such a move.

There are some alternatives that allow for common ground. One of the most elementary portfolio combinations is to pair the Standard & Poor's Depositary Receipts (SPY) — an ETF known as Spiders that tracks the S&P 500 index — with iShares MSCI EAFE (EFA). The latter owns stocks in Europe, Australasia and the Far East. An investor could also add a fund or two on the fringes to get some potential extra returns. If he thought the U.S. was going to lag the rest of the world, he could buy the SPDR MSCI ACWI ex-U.S. ETF (CWI) that invests in prominent markets outside the U.S. The same goes for those who are bearish on countries like Japan. A final option is to build your own index. Some advisors have started pairing core holdings like the Spiders with ETFs that are focused on specific countries. That's one way to avoid our Swiss bank conundrum.