VEA: Favorably Valued With Lower Risk Than Emerging Markets

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VEA is a buy due to solid outlook for developed markets including Japan, its low expense ratio, high diversification, and substantial dividend yield.VEA excludes emerging markets and therefore reduces...

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href=https://seekingalpha.com/article/4699487-vea-favorably-valued-with-lower-risk-than-emerging-markets><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>VEA is a buy due to solid outlook for developed markets including Japan, its low expense ratio, high diversification, and substantial dividend yield.VEA excludes emerging markets and therefore reduces...</p>\n\n<a href=\"https://seekingalpha.com/article/4699487-vea-favorably-valued-with-lower-risk-than-emerging-markets\">Source 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Zhixing Xu/iStock via Getty Images Investment Thesis Vanguard FTSE Developed Markets ETF (NYSEARCA:VEA) is a buy due to the solid outlook for developed markets and its current valuation compared to the U.S. market. Additionally, by only including developed markets, VEA avoids some risks specific to emerging markets. Compared to peer funds, VEA has a very low expense ratio, offers a high amount of diversification, and includes a substantial dividend yield in addition to its potential for capital appreciation. Fund Overview and Compared ETFs VEA is a passively managed ETF that seeks to track the FTSE Developed All Cap ex US Index. With its inception in 2007, the fund has 3,979 holdings and $194.6B in AUM. The Vanguard fund includes foreign stocks with a mix of large, mid, and small-cap companies. VEA is an ETF that captures developed markets other than the United States and excludes emerging markets. It therefore has 54.7% weight in Europe, 35.2% weight in the Pacific, and the remainder in the Middle East and North America. Its largest weight by country is in Japan at 21.2% weight, followed by the United Kingdom (13.1%) and Canada (9.5%). For comparison purposes, other funds examined are iShares Core MSCI Total International Stock ETF (IXUS), Goldman Sachs ActiveBeta International Equity ETF (GSIE), and Hartford Multifactor Developed Markets (ex-US) ETF (RODM). IXUS is a total international stock ETF and therefore has 21% in emerging markets including 6.79% weight in China. It was included to compare with an international ETF that incorporates emerging markets. GSIE is a developed market ETF that also excludes emerging markets and utilizes a specific methodology to capture holdings based on value, momentum, quality, and low volatility. The fund is also the heaviest on Europe, with the largest weight by nation in Japan at 20.3%. Similarly to VEA and GSIE, RODM is a developed markets ETF that excludes emerging markets. However, RODM uses a non-cap weighted strategy and therefore has a more equally distributed weight on its 329 holdings. Fund Comparison: Performance, Expense Ratio, and Dividend Yield VEA has a 5-year average return of 8.19% with a total price return of 21.1%. Therefore, it achieved the best recent performance compared to peer funds. By comparison, IXUS average annual 5-year return was 6.10% and GSIE’s 5-year average annual return was 7.66%. RODM saw the lowest performance with a 5-year CAGR of 4.75%. While all funds underperformed U.S. markets, as measured by the S&P 500 Index, there are reasons to be bullish on developed markets looking forward, as I will discuss later.   5-Year Total Price Return: VEA and Peer International Funds (Seeking Alpha) VEA offers the lowest expense ratio of compared funds at just 0.06%. Additionally, all international funds have dividend yields higher than U.S. total market and S&P 500 ETFs. VEA specifically has a substantial 3.28% yield along with a 5-year dividend CAGR of 5.43%. Expense Ratio, AUM, and Dividend Yield Comparison     VEA IXUS GSIE RODM   Expense Ratio 0.06% 0.07% 0.25% 0.29%   AUM $194.60B $36.47B $3.58B $1.11B   Dividend Yield TTM 3.28% 3.01% 2.55% 4.31%   Dividend Growth 5 YR CAGR 5.43% 5.18% 4.02% 18.32%   Click to enlarge Source: Seeking Alpha, 15 Jun 24 VEA Holdings and Key Outlook Factors VEA offers massive diversification with almost 4,000 holdings. Only IXUS is more diversified but includes emerging markets also. As I will cover later, emerging markets have several drawbacks from a risk standpoint. Several similar companies are common in the top weights including Novo Nordisk (NVO) [XSCE:NOVO.B], ASML Holding (ASML), and Nestle [XSWX:NESN] (OTCPK:NSRGY). Top 10 Holdings for VEA and Peer International ETFs   VEA – 3,979 holdings IXUS – 4,447 holdings GSIE – 704 holdings RODM – 329 holdings   NOVO B – 1.77% 2330 – 2.30% NOVO B – 2.30% BA.L – 1.05%   ASML – 1.59% XTSLA – 1.57% ASML – 1.60% NOVO B – 1.02%   NESN – 1.20% NOVO B – 1.51% NESN – 1.10% ROG.SW – 1.00%   7203 – 1.10% ASML – 1.37% MC – 1.00% CNA.L – 0.99%   005930 – 1.07% 700 – 1.05% NOVN – 1.00% NOVN.SW – 0.99%   SHEL – 0.99% NESN – 0.93% AZN – 0.90% AD.AS – 0.98%   AZN – 0.97% 005930 – 0.90% RHHBY – 0.90% SAN.PA – 0.95%   NOVN – 0.91% AZN – 0.80% SHEL – 0.80% ANZ – 0.95%   SAP – 0.85% SHEL – 0.74% SAP – 0.80% FFH.U – 0.93%   MC – 0.84% MC – 0.71% TOT – 0.70% GSK – 0.93%   Click to enlarge Source: Multiple, compiled by author on 15 Jun 24 Looking forward, there are three reasons why I have been adding VEA to my portfolio. The first is that the fund’s greatest weight by nation is in Japan which has been showing some promising market indicators. The second is that VEA excludes emerging markets which, while favorably valued, have certain unique risk factors. Finally, VEA offers diversification from the U.S. market, which is currently highly priced, compared to historical indicators. Optimistic About Japan’s Growth The first reason why I have been buying VEA is due to its weight on Japanese companies. Following loose monetary policy, the Japanese market saw a high amount of speculation leading to a bubble in the late 1980s, which popped in the early 1990s. This led to a “lost” 20 years with low GDP growth and a stagnant market. While Japan is still seeing low GDP growth, there are a few indications that its market is poised for a comeback. First, Japanese companies are seeing strong earnings growth. For example, Toyota Motor Corporation (TYO:7203), VEA’s #4 holding, has seen 69% YoY EBITDA growth with a 21.4% YoY revenue growth. After nearly 25 years of deflation, Japan also has recently seen inflation. This has led to the Bank of Japan increasing interest rates above their negative rate. As a result of these conditions, the Tokyo Stock Price Index or TOPIX has seen a strong recent return. Looking forward, Goldman Sachs projects 8% earnings per share growth through the remainder of this year and 7% additional growth in 2025.   Tokyo Stock Price Index Forecast (Goldman Sachs) Interestingly, a significant number of investors are also taking note. For instance, Warren Buffett stated last year that Berkshire Hathaway (BRK.A) (BRK.B) was adding to its holdings of five Japanese companies. In one month alone last year, foreign investors bought $15.6B of Japanese stock. Due to a combination of the nation’s monetary policies as well as strong earnings for top holdings, there are reasons to be optimistic about Japan’s market outlook. Concerns about Emerging Markets The second key advantage for VEA is that the fund excludes emerging markets. Roughly one-third of the weight of most emerging market funds is in China. Over the past 10 years, while the S&P 500, measured by SPDR S&P 500 ETF (SPY), has seen a total price return of 177%, iShares MSCI China ETF (MCHI) has seen a -7% return. Of note, VEA saw a 14% return over the same time period. As a result of these price return disparities, the most attractive quality for emerging markets is their valuation. While the U.S. market is notably higher than its own 15-year average, emerging markets are below their average.   U.S. versus Emerging Market P/E Ratios (Morningstar) Despite this disparity in valuations, I do not see this as reason enough to offset the risks associated with emerging markets, particularly China. Due to tensions between the U.S. and Chinese governments, certain Chinese companies have been “blacklisted” for U.S. investment. Individual holdings such as Tencent (XHKG:700) or Alibaba (XHKG:89988) have even been considered in the past. China has seen strong GDP growth of 5.3% in 2023. However, I see this benefit as offset by potential tariffs and investment bans. I wrote recently how the European Union is looking to impose tariffs on Chinese carmaker BYD’s vehicles due to their low prices that undercut European car companies. As a result, I favor developed market ETFs such as VEA more than emerging market funds. Diversification Away from Pricey U.S. Markets The third competitive advantage for VEA is its ability to help investors diversify internationally away from U.S. equities. While U.S. markets have seen tremendous returns over the past 10 years, this has resulting in a high valuation for U.S. equities. I wrote about this in a previous article for Vanguard’s Consumer Staples Fund (VDC), including a high cyclically adjusted price-to-earnings ratio. Perhaps even more concerning is the skyrocketing U.S. debt which has now reached over 120% as a percentage of U.S. GDP.   Increasing U.S. Debt as Percentage of GDP (St Louis Fed, www.economicshelp.org) While the U.S. economy is inexorably linked to developed markets, international investment can serve to reduce the impact if the U.S. reaches a debt crisis. As a result of this high debt to GDP ratio, investors have been seeking gold and other alternatives such as cryptocurrency. This has been seen with gold’s share price increasing almost 20% over this past year and bitcoin prices rising over 150% over the past year. Current Valuation  Consistent with the previous decade’s performance, developed market ETFs, including VEA, have underperformed U.S. markets. Specifically, VEA has seen a return of just 5.57% over the past year, which is roughly on par with its peers.   One-Year Performance: VEA and Compared International ETFs (Seeking Alpha) Interestingly, VEA is more favorably valued than IXUS that includes emerging markets. However, the Vanguard fund has a greater P/E than GSIE which is also focused on developed markets. RODM has the most favorable P/E and P/B, predominantly due to its modified equal weight strategy and underperformance over the past five years. Valuation Metrics for VEA and Peer Competitors     VEA IXUS GSIE RODM   P/E ratio 15.60 15.71 14.44 10.47   P/B ratio 1.70 1.83 1.75 1.50   Click to enlarge Source: Compiled by Author from Multiple Sources, 15 Jun 24 Risks to Investors While developed markets have more attractive valuations currently, they are highly correlated with U.S. markets. VEA has a beta value, or measure of correlation, of 0.94 with the S&P 500 Index. This high level of correlation meant that during the great recession of 2007-2008, while the S&P 500 dropped about 57%, VEA saw a 56% decline. Therefore, while VEA is more attractively valued, a steep correction or bear market in the U.S. will very likely result in poor performance for VEA as well. In addition to a high correlation to U.S. markets, the second key factor is geopolitical risk. The ongoing conflict in Ukraine and continued Russian aggressiveness poses a threat to European markets. Additionally, the second highest geographic weight is on Asia-Pacific holdings which faces uncertainty with risk of conflict in the South China Sea and China’s ambitions to reunify Taiwan. Concluding Summary  VEA is a low-cost, highly diversified ETF that captures developed markets. Looking forward, I rate VEA a buy due to the strong outlook for Japan, its exclusion of emerging markets which represent certain significant risks, and diversification away from overvalued U.S. equities.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2443976549"}