We run through some of the main choices that investors face when going through the ETF selection. We toss up the options with international ETF choices, and point to a few factors that investors should look for when choosing between similar ETFs.

Listen on:

You can find the full article here.

Mark has written through the full process, including an ETF pick for income here.

You’re able to find the transcript for the episode below:

Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.

Mark LaMonica: Shani, before this podcast started, you apparently have a funny story to tell about me.

Jayamanne: Well, you were saying that we always talk about, oh, like, what should we talk about from our personal lives in this podcast this time? And we said, maybe we talk about lunch. We went to lunch yesterday.

LaMonica: It’s a place that we’ve been a lot.

Jayamanne: Yeah, it’s close to the office. And we really like it. It’s a Chinese place. And they’ve completely changed the menu. So it’s all Thai food now.

LaMonica: But the funny thing is they didn’t change anything else.

Jayamanne: No. Like, it’s still old Chinese decor.

LaMonica: It still has the same name that it had before. It’s just they changed the menu. And you get very upset at this because going to lunch with Shani is this huge process because she has to figure out what she feels like. And then she’s like laser focused on it. And you wanted to get this like…

Jayamanne: It’s like this chicken broth thing that I love.

LaMonica: And they didn’t have it.

Jayamanne: No. And so I didn’t get to have that. But the funny part of this was we were talking about it before this and Mark started a column called Unconventional Wisdom. And at the end of the column, he puts pictures of food that he’s had recently. And he’s like, oh, I only really have pictures of food at really fancy places. And I don’t want people to judge me. So I’ve got to take photos in povo places too. And so he’s like, I should have taken photos at my povo lunch with you yesterday.

LaMonica: Wow, Shani. Thank you for that. Since I bought your lunch, maybe you should be a little more appreciative, but...

Jayamanne: Anyway. So Mark likes dining at very fancy places. I feel like you should just own it and you should just upload the photos.

LaMonica: First of all, you do as well.

Jayamanne: I just don’t do it as often.

LaMonica: Anyway, today, we’re going to talk about ETFs, always a popular episode. And we’re going to talk about the process that you go through when picking an ETF. And I think we both feel like there’s this misconception about ETFs. So they’re often portrayed as investments for beginner investors. And I think that’s because they track well-known indexes, or they have easy to understand themes. They’re straightforward to trade. They’re more approachable than picking individual shares. However, we still think that all investors should be cautious before choosing an ETF. So there’s a big difference from buying an investment, which in theory anyone can do, and then finding the right investment for you.

Jayamanne: And choosing an ETF requires thoughtful analysis about whether it is the right investment to help you reach your goals over the long term. We speak about this a bit on the podcast, but the investment product industry is not really there to serve your best interests.

LaMonica: We are.

Jayamanne: I guess we sell investment products too. We don’t just chat. It’s there to create products depending on the demand in the market. So there’s a lot more ETFs coming onto the market that are slickly marketed and play on the appeal of a popular theme.

LaMonica: Yeah. And so we just think that there should be healthy skepticism about the financial services industry and the products they roll out. We think it’s just helpful to go into it with that attitude.

Jayamanne: Yeah. So today we’re going to go through the process of finding an international equity ETF.

LaMonica: All right. We’re going to go through the steps first. And we have talked about these before. It starts with reviewing goals and investment strategy, assessing the ETF mandate. So based on the criteria that you set, reviewing how the mandate is implemented, and then review the rules governing changes to the ETF holdings.

Jayamanne: So let’s start at the beginning, understanding your goals and your investment strategy.

LaMonica: So many investors immediately jump to choosing investments because, right, that’s supposed to be the fun part of this whole thing. And they skip this process of investing. And investing is the process of defining what you want to accomplish and finding the investments that fit your criteria. So before logging onto your broker, clearly define your investment objectives. And we talk about this all the time. So if you want to walk through, go to our ‘How to Construct a Portfolio’ episode, still my favorite episode.

Jayamanne: It’s a good episode.

LaMonica: And we did that one very early.

Jayamanne: That was an early one.

LaMonica: Like 500 podcasts ago.

Jayamanne: Yeah.

LaMonica: What number are we on?

Jayamanne: I think we’re around 240, 250 at the moment. It’s a lot of podcasts.

LaMonica: You know, 250, Will’s thinking, yes, it’s a lot of podcasts.

Jayamanne: Yes, he’s nodding at us.

LaMonica: If it’s 250, that’s a milestone.

Jayamanne: Yeah. We should celebrate.

LaMonica: We can’t because you’re going to Europe for a month. But anyway, go back and listen to that How to Construct a Portfolio episode. And we just go through that entire process. You start with understanding the asset class exposure that you need, given the rate of return you need to achieve your goals, and then you go from there.

Jayamanne: So for this financial goal, we’re finding international equity exposure. That’s for the long term. We don’t need to access it for at least the next decade. And I’m not focusing on driving any income from the portfolio in the meantime. So it’ll sit in a portfolio that is heavily tilted towards aggressive assets. I’m looking for broad international equity exposure for a holding period of 10-plus years.

LaMonica: And so that, like, that is not hard to do, but it’s just writing that down and defining that really helps to put structure around this. So once you’ve gone through that process, you’ll have a clear understanding of what you want to achieve. And just understanding that objective makes it easier to identify the criteria to find ETFs. And, we should note there’s a lot of ETFs out there.

Jayamanne: There are. And so the second step is assessing the mandate against your criteria. So each ETF has an investment mandate, and that outlines its objectives, approach, and any guidelines on what the ETF can or can’t invest in. And the mandate is one of the best ways to determine if a specific ETF aligns with the objectives that you want to achieve. And finding an international ETF is very broad. But what we can do is narrow down the list with further criteria from the investment strategy that we went through before.

LaMonica: Okay. So we’ll go back to that. That’s the strategy that Shani went through. So one thing is a long-holding period. So we know that what matters is returns achieved after taxes and fees. So we want to keep, of course, taxes and fees as low as possible. We also want to find low-cost vehicles with low turnover, because that is how you get low fees and tax efficiency. So in this instance, we’re happy to exchange volatility, so how much it’s going to bounce around in price for long-term returns. Long-holding periods reduce the risk of making poor timing decisions on the purchase and sale of ETFs.

Jayamanne: And the second part of this is that international equity exposure part. And international equity exposure is a broad category, as we said. So let’s narrow down the global investable universe. Options include narrowing it down to the developed world or a few specific countries. I could divide global shares into small, mid, or large-cap companies. I could pick an active or passive approach. So there’s lots of ways to slice the pie. But I think there are about 176 international equity ETFs listed in Australia at the beginning of 2025. The focus here is on broad exposure to shares, which eliminates narrow mandates such as thematic ETFs or sector-specific ETFs.

LaMonica: So we’ve excluded the process we’re going through. We’ve excluded thematic or sector-specific ETFs for a few reasons. And I think that’s because if you invest in them, it assumes a couple things, Shani.

Jayamanne: Yeah, it does. So it assumes that I picked the right theme or narrow part of a broader market. And it assumes stocks that fit that theme aren’t already fully valued. And it assumes I picked the right fund provider to execute investments in this theme.

LaMonica: And I think just going through that shows that that’s harder to do. So yeah, we’re trying to simplify this process. So let’s move on to our next step. So you’ll want to conduct this exercise for each part of your portfolio, but it’s deciding on an active or passive strategy.

Jayamanne: That’s right. And Morningstar conducts a bi-annual research report called the active passive barometer, which Mark declares is not his favorite report.

LaMonica: No, I don’t, usually I think I’m going to get fired for this.

Jayamanne: No.You’re allowed to have preferences. It outlines where active managers have typically underperformed. Although past performance isn’t an indicator of future performance, as we know, it does give valuable insights into the types of markets where an active manager may be able to add value and where passive investments may fare better.

LaMonica: So overall, Shani, the general theme of this report is that passive investments tend to outperform active over the long term in most sectors and markets. And one big reason for this is they’re handicapped by high fee levels that they have to overcome before beating that benchmark.

Jayamanne: So what we do see though is that there are areas where active managers are able to add value. There are sectors and asset classes that might not be well covered by analysts in the broader market where they’re able to find opportunities. Examples of this include realistic funds and bond funds.

LaMonica: And if anyone’s interested in this, this report is free. So you can go in and see these different sectors and see how active versus passive performed. So you can just find this by searching for the active passive barometer report on Google.

Jayamanne: Or your chosen search engine. We have no preference.

LaMonica: Yes.

Jayamanne: Yeah, we’re independent here. But with those results, we don’t believe the track record for active managers is strong enough to justify choosing an active fund for a long term investment.

William Ton: I’m Will, producer of Investing Compass and here are this week’s must reads on Morningstar.com.au. Can you fit everything you need to know to build wealth onto a single index card? One professor in the US seems to think so. In this week’s Unconventional Wisdom column, Mark challenges Harold Pollack’s one size fits all rules for wealth and whether they hold up to the test. Shani’s still on leave. So her featured article this week is a rerun of the special future focus she published to mark International Women’s Day. In this edition, Shani looked at ways that women have taken back control of their finances, in context to where the odds are stacked against them. This includes a personal story about Shani’s Sri Lankan heritage, where gold is traditionally used as a store of emergency source of wealth.

New investors can be especially vulnerable to hot stock tips and taking punts on individual investments they later regret. In this week’s Young & Invested, Sim shares how a string of poor stock picks as a new investor left her disillusioned and ultimately led her to invest through ETFs instead. Joseph’s featured article this week is the latest edition of Ask the Analyst. This time, Joseph caught up with Morningstar’s global mining analyst Jon Mills on what is probably one of the hottest assets right now, gold. As it turns out, Jon holds a very different view to the market on both the price outlook for gold and the valuations that many gold mining stocks today have. These articles and more they are now available in the show notes. And let’s get back to Mark and Shani.

Jayamanne: So the next step is reviewing how the mandate is implemented. Most developed markets require fund managers to display their entire holdings list and it’s pretty frustrating that this isn’t the case in Australia, isn’t it, Mark?

LaMonica: You just do this because you like it when I get angry on these things. But I am going to be calm while I talk about how in Australia, for some unknown reason, managers only reveal their top 10 holdings or they delay the release in their holdings by 90 days. So in theory, this is supposed to protect their intellectual property. But in reality, it just makes it more difficult for investors to understand what they’re investing in. And I think both of us are big fans of transparency. We faced that yesterday with lunch. There was no transparency that this place changed from Chinese to Thai.

Jayamanne: They’re two different countries.

LaMonica: Yes, they are. They are. But anyway, we think transparency is helpful. We get the holdings from ETFs and funds, though, at Morningstar. So that makes it easier for us and hopefully to help you find something that fits your criteria.

Jayamanne: And understanding the exposure helps you assess how the ETF fits into your portfolio and whether it complements your existing investments. So you can look for overlap with existing holdings.

LaMonica: So we did a search for passive international ETFs and broad ETFs. So the main ones that we came up with, there is Betashares, Global Shares ETF, BGBL is the ticker symbol for that. There’s iShares Core MSCI World ex Australia ESG ETF. That’s a mouthful, IWLD. And there’s Vanguard, MISCI International ETF. And you did not write down the ticker symbol. But luckily and pathetically, I know that it’s VGS.

Jayamanne: It is VGS. We’ve got a proper side-by-side comparison in an article. So we will link that in the episode notes. But we’re going to go through the main influences of after-tax, after-fee returns of an ETF. There’s so many similar ETFs on the market that it could be the tiebreaker that makes the difference.

LaMonica: Okay, and the first is portfolio turnover. Turnover just refers to how often the underlying holdings in a fund or ETF are rotated. So ETFs with low turnover have higher tax efficiency, which of course may lead to better after-tax returns. And turnovers typically cause by rebalancing or if there is a periodic rerunning of the security selection criteria. And you can see that in that fund mandate. So it will stipulate how often this portfolio needs to be rebalanced. And if it’s frequently that will influence that portfolio turnover rate and the tax that you will owe. So the portfolio turnover rate for IWLD is 4.92%, VGS is 1.38%, and BGBL is not available.

Jayamanne: Not available. Then there’s volatility and long-term objectives. As this is a long-term investment, volatility is not a key consideration. However, if you are drawing down on an investment or have a shorter time horizon, beta or volatility might be an important consideration. So do keep that in mind if that’s something that’s relevant to you.

LaMonica: Or standard deviation. Depending upon what kind of volatility stat you’re looking for. When you were a little girl, did you think someday I’m going to be talking about different volatility measures…

Jayamanne: No, I did not.

LaMonica: …on a podcast. No, you thought you were going to be Harry Potter.

Jayamanne: I did.

LaMonica: We’re going to turn to fees. So fees are of course a big one. There are, Shani was Harry Potter. She could make fees disappear, right?

Jayamanne: Even Harry Potter doesn’t have that much power, Mark.

LaMonica: Okay. Well, there we go. John Bogle made a lot of fees disappear. So maybe you should have been more into him when you were younger. But there are several fees that are attached to an ETF. If you can’t make them disappear. Shani’s written about the total cost of owning an ETF. We will put that link in the podcast notes. But you should think about all these fees on a total cost basis. So high fees are drag on returns. And this should be the determining factor if ETFs are basically identical. And if different providers happen to even be tracking the same index.

Jayamanne: And then for international equities in particular, there’s hedged or unhedged. And international equity ETFs have two main components of return. There’s the return of the underlying investment and changes in exchange rate. And hedge investments remove the currency component of the return, resulting in just getting the investment return. And there are several factors that influence the relative performance of currencies. There’s geopolitical situations, there’s relative levels of interest rates and inflation. Those are some of the factors that might influence currencies. And to correctly make a directional bet on currency is really hard, given the tax and transaction costs of switching between hedge and unhedged products. It means we really want to stick with the choice over the long term.

LaMonica: And people are very into this because every time I do, I just finished up a series of ETF webinars. There’s like lots of chatter in the little chat feature of this…

Jayamanne: About hedged or unhedged.

LaMonica: Yeah, people feel very passionately about it.

Jayamanne: How do you feel about it?

LaMonica: Not as passionately, not as passionately. But one thing is what we always talk about. It’s really based on your personal circumstances. And I think that’s a reason for me. So I don’t typically invest globally in Australia because I still have US accounts and I just do it there. So that’s an example of a personal circumstance impacting how you actually invest. But we go through in other episodes those personal circumstances and how to kind of think through what you’re going to pick in the Shani set for the long term. Something you hold for the long term.

Jayamanne: Yeah. And if you wanted to look up that episode, it’s called the ‘Should Investors Hedge at Their Portfolios’. So lastly, it is to look past the marketing material. And ETF providers are trying to sell you a product. Look beyond the surface level descriptions of an ETF to understand how it works.

LaMonica: For actively managed ETFs, you need to look at the manager’s track record. So do they have a history of acting in investors’ best interest? Is there high turnover within the management team? You don’t want to see constantly rotating portfolio managers.

Jayamanne: Exactly. And it’s difficult to predict the future decisions of a fund manager. But what we can do, is we can have a look at the past track record and how they have approached governing and running their funds can provide some idea.

LaMonica: So we’ll give you an example, an ETF example. So iShares owner BlackRock, so BlackRock is a company that puts out iShares ETFs. They changed the index that IWLD tracks to an ESG index. And they did this to a few more of the ETFs that they have as part of their product suite at the end of 2022. So doing this means that ETF divested out of certain industries that did not align with that ESG index.

Jayamanne: And as an investor, this is a pretty alarming decision. Previous investors weren’t given a choice about whether they wanted to track an ESG index. And the switch in index likely results in capital gains as sectors, companies, and non-ESG friendly investments were solved.

LaMonica: Yeah. And it’s not like there were not ESG ETFs that you could have accessed if you wanted that. So decisions like that is an example that should and potentially would play a role in your decision-making process over which investments to choose. So if there’s a history of what you consider a poor decision, it may be worth considering other options. So this may not be as important to you. You may be more focused on keeping fees as low as possible. But that’s why you want to outline that criteria if things are important to you. So depending on your selection criteria and that investment policy statement, the one that Shani talked about earlier, one factor may carry more weight than another. So we’re not going to make that decision. We can barely make decisions.

Jayamanne: As it is.

LaMonica: As it is. Exactly.

Jayamanne: Don’t make us make a decision. Choosing an ETF requires balancing your investment goals and the specifics of the fund. And they’re not custom investments and will never be tailored perfectly for your purposes. So the aim of the game is really to find the closest match that suits you. And you can do this by matching the ETFs mandate, analyzing its exposure and how it operates, and really just cutting through that market noise. And carefully considering each set of criteria may mean better long-term outcomes and peace of mind for you.

LaMonica: And one decision we would encourage everyone to make is to listen to the next episode of Investing Compass because this one is over, Shani.

Jayamanne: It’s done.

LaMonica: Yes. Now we can talk about your little rant about where I like to go out and eat meals. But thank you guys very much for listening. Go to the show notes. We have the links to those other episodes that we talked about. And my email address is in there. So if you have any comments on Shani’s betrayal, you can email me at [email protected].

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)

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