The MSCI EAFE index tracks equities in developed economies of Europe, Australia and the Far East (hence the EAFE acronym) and is the simplest way for Canadians to get exposure to markets in Japan, United Kingdom, France, Germany, Switzerland and Australia etc.

Two ETFs, both from iShares, are available to capture the performance of the index: iShares MSCI EAFE Index Fund (Ticker EFA), listed on the U.S. exchanges and iShares CDN MSCI EAFE Index Fund (Ticker XIN), listed on the TSX. Though the EFA is denominated in US dollars, Canadian investors are exposed to the currency rate fluctuations between our dollar and a basket of currencies such as the Euro, Yen and Pound etc., not the U.S. dollar. XIN simply holds the EFA and adds a currency hedge on top of it, so a Canadian investor would capture the returns of the MSCI EAFE index (less fees and expenses) in their respective local currencies. The MER for EFA is 0.35% and 0.50% for the XIN.

My personal preference is to hold the EFA directly because hedging is of dubious value when a basket of currencies are involved. In any given year, the Canadian dollar might gain against the Yen, drop against the Pound, gain against the Euro etc. In fact, while our dollar has appreciated strongly against the greenback in the past five years, it is trading within a tight range against other major currencies.

The exploding popularity of ETFs has attracted competition and the Vanguard group has introduced two ETFs that taken together represent the MSCI EAFE index. The Vanguard European ETF (Ticker VGK) tracks the MSCI Europe Index and the Vanguard Pacific ETF (Ticker VPL) tracks the MSCI Pacific Index. If you invest three-quarters of your money in VGK and one-quarter in VPL, you’ll roughly track the performance of EFA. Why would you bother investing in two ETFs, instead of one? Because the Vanguard ETFs are significantly cheaper and charge a MER of 0.18%. Still, depending on the size of your portfolio, we are talking about relatively small sums of money. The Sleepy Portfolio, for instance, has $20,000 invested in EAFE markets. Switching from EFA to VGL and VPL would save a princely sum of $34 per year, offset by the extra commissions involved in switching.

Update: After this post was published, Vanguard introduced the Vanguard Europe Pacific ETF, an even better option for investing in foreign developed markets.

This article has 9 comments

  1. Another good ETF post.

    Regarding your comment about switching EFA to VGL and VPL in the Sleepy Portfolio – if the cost to switch is $60 and the annual saving is $34 – this is still a worthwhile move since the payback will be in two years.

  2. I’ve been pondering the same thing, which international ETF to invest in. I liked the idea of splitting my allocation between VGK (Europe 0.18% MER) and VPL (Pacific 0.18% MER) but without VWO (Emerging Mkts 0.3% MER) the international component would not be complete.

    Just over a month ago Vanguard introduced their “All World excluding US” ETF, VEU. It covers the whole planet except for the US, including emerging markets, in proportion to the size of each economy. It has an MER of 0.25% which is slightly higher than the average of VGK, VPL and VWO but unless your portfolio is large this will be more than made up for in the lower commissions for (annual?) rebalancing.

    My other issue was I knew I would spend hours (weeks?) figuring out my allocation between Europe, Pacific and Emerging and probably trying to time the market unsuccessfully.

    Now I’ve simplified the bulk of my portfolio down to a bond fund, Canadian equity ETF (XIU), US equity ETF (VTI) and a Global equity ETF VEU.

  3. That’s interesting Griff.

    I was thinking that for a typical investor, if you are making semi or annual ETF purchases, then the EFA would probably be better because of lower transaction fees.

  4. Canadian Capitalist

    Griff: My next post on ETFs is VWO and I’ve already mentioned it other posts. I read about the VEU in media reports, but I haven’t had a chance to look at it.

    Mike: The decision between EFA and VGK+VPL is also complicated by how often rebalancing is required. For now, I am happy to hold EFA in my personal portfolios and if the position becomes large enough, I’ll consider switching.

  5. Canadian Capitalist

    Griff: VEU will be attractive for US investors wanting a one-decision foreign exposure ETF. Unfortunately, for Canadian investors, VEU also has a 5% exposure to our equities market. It is not a huge concern, as you can calibrate exposure to Canadian equities accordingly. My preference is to still stick with EFA+VWO but definitely VEU will be an attractive alternative.

  6. CC: what do you think of Claymore’s CIE? I like that it is fundamentals based … (http://www.claymoreinvestments.ca/ETFs/Public/fund/Overview.aspx?ID=78becf0d-407a-4627-8ef8-db750701f82d)

    I’ve noticed that Japan composes a large chunk of this ETF … is that a justified bias?

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  8. By holding US ETF in a Canadian portfolio, the value of the ETF will be affected by the value of $CAN compared to $US in case of selling, isn’t it?

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