Introduction
The iShares Core MSCI Total International Stock ETF (NASDAQ:IXUS) has underperformed the Vanguard Total Stock Market Index Fund ETF (VTI) so far in 2024, delivering a mid-single-digit total return against the ~15% gain in the broad U.S. market ETF:
Over a three-year time frame, the underperformance is even greater, at almost 25%:
This poor performance of international stocks has resulted in them offering significantly higher earnings and dividend yields compared to US peers. What’s more, as the Fed is likely to start cutting rates in a few months, we may see a partial unwind of the US dollar’s outperformance. Combined with the upcoming US presidential election, I think it makes sense to increase allocations to international shares, with IXUS offering a well-diversified and cheap way to do so.
ETF Overview
You can access all relevant IXUS information on the iShares website here. The iShares Core MSCI Total International Stock ETF tracks large, mid, and small-cap companies outside the United States. From a geographic perspective, its largest allocation is to Japan (15.7% of net assets), followed by the United Kingdom (9.50%) and Canada (7.45%):
From a sector perspective, the ETF has allocated its assets primarily to Financials (20.45% of net assets), followed by Industrials (14.77%), Information Technology (13.28%), and consumer Discretionary (11.03%):
Inexpensive diversification
IXUS has investments in some 4,433 companies, highlighting its immense global diversification. All fund holdings are available here. As a result, the ETF’s top ten holdings account for just 10.75% of its net assets – well below the 31.26% allocation VTI has to its ten largest positions. From an expense viewpoint, VTI is still cheaper, although only marginally so – its expense ratio is 0.03% versus the 0.07% for IXUS.
Sector allocation comparison
I will now compare how IXUS and VTI match up from a sector allocation perspective, with the results shown in the table below:
SectorETF allocation % | IXUS | VTI | Difference |
Financials | 20.45 | 10.5 | +9.95 |
Industrials | 14.77 | 12.10 | +2.67 |
Information Technology | 13.28 | 35.20 | -21.92 |
Consumer Discretionary | 11.03 | 13.80 | -2.77 |
Health Care | 9.04 | 11.40 | -2.36 |
Materials | 7.59 | 1.70 | 5.89 |
Consumer Staples | 7.21 | 4.30 | 2.91 |
Energy | 5.25 | 3.90 | 1.35 |
Communication | 5.05 | 1.90 | 3.15 |
Utilities | 3.10 | 2.60 | 0.5 |
Real Estate | 2.84 | 2.60 | 0.24 |
Source: Author calculations based on iShares and Vanguard disclosures
From the table above we observe that the iShares Core MSCI Total International Stock ETF is most notably underweight the Information Technology sector, by about -21.92%, followed by smaller allocations to Consumer Discretionary (-2.77%) and Health Care (-2.36%). In contrast, the IXUS ETF is overweight all other sectors, most notably Financials (+9.95%) and Materials (+5.89%).
Given the outlook for lower interest rates around the world, the large allocation IXUS has two Financial stocks is a clear red flag. On the other hand, if you share my opinion that Information Technology is due for a pullback after the stellar performance in 2023-2024, the significant underweight position IXUS has in the sector makes all the sense in the world.
We should also note the IXUS is overweight interest rate sensitive sectors such as Communication, Utilities, and Real Estate by a cumulative 3.89%. I expect them to do well in a lower interest rate environment.
From an economic cycle perspective, IXUS is underweight Health Care but overweight Consumer Staples, which largely negate each other. The large overweight position in Materials and Industrials, however, makes IXUS more of a cyclical play in my opinion, partially offset by an underweight in Consumer Cyclical stocks.
Valuation and distributions
The iShares Core MSCI Total International Stock ETF components currently trade at a P/E ratio of 15.93 or an earnings yield of about 6.2% after ETF expenses. In contrast, the P/E ratio of VTI stands at 25.9, or an earnings yield of just 3.83% after ETF expenses. To break even, the VTI would have to grow its earnings some 2.37% faster than IXUS, which I see as unsustainable in the long term.
The difference in dividend yields is also quite pronounced. IXUS currently yields about 3.02%, well above the 1.35% yield offered by VTI. We should note that IXUS pays semiannual dividends versus quarterly distributions at VTI.
US Dollar Outlook
The US Dollar Index (DXY) has gained about 12.3% over the past three years, which partially explains the underperformance of IXUS (which is traded in USD):
I believe that the strong US dollar performance may be due to the large interest rate differential that emerged with the Fed rate rising cycle in 2022-2023. While rates in the United Kingdom are comparable to those set by the Fed, they are lower in China, Canada, Australia, and the Eurozone and materially lower in Switzerland and Japan. In fact, out of the countries IXUS has a significant allocation to, only India boasts a higher central bank rate than the US:
As the Fed looks set to cut interest rates over the next few years, some of this interest rate differential may diminish, potentially unwinding part of the carry trade that fueled the US Dollar Index’s rise over the past three years.
Risks
As I mentioned above, I think the largest risk of going long IXUS is the high overweight position in the Financial sector, at +9.95% relative to VTI. Even if we account for the 3.89% overweight allocation in lower rate beneficiaries such as Communication, Utilities, and Real Estate, IXUS is still exposed to interest rate risk. What’s more, Financial stocks are quite sensitive to the economic cycle, which coupled with the high Materials and Industrials exposure makes IXUS a clearly more cyclical ETF.
The other long-term risk to mention is that IXUS has high exposure to countries with poor demographic prospects, such as Japan (15.7% of net assets), China and Hong Kong (7.48%), South Korea (3.48%), Taiwan (5.61%). Likewise, the population growth outlook for much of Europe is not much brighter either. Combined, I estimate some 40% of IXUS net assets are allocated to countries that are set to see a material population decrease this century, which will impact the potential growth of their economies.
Conclusion
The iShares Core MSCI Total International Stock ETF has underperformed its US benchmark, the Vanguard Total Stock Market Index Fund ETF, both in 2024 and over the past three years. This has resulted in IXUS offering a significantly higher earnings yield compared to VTI, notwithstanding the somewhat cyclical tilt of the international ETF. The IXUS return outlook is in the high single digits, driven by a 6.2% earnings yield after taxes, a 2% inflation component, and perhaps some unwind of the US dollar strength, which would be a plus for US investors.
International investors who have profited from the combined outperformance of US stocks and the US dollar may also want to increase their international allocation, as I believe the US market may underperform in the run-up to the November presidential election.
Thank you for reading.
Read the full article here