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International stock market bets US investors won’t touch

  • International technology stocks are posting returns that beat the U.S. tech market.
  • Overseas IPOs are performing better than U.S.-listed IPOs in 2017.

American investors have always been provincial. When you have the largest and most reliable stock market in the world, that's a luxury you can afford.

But a U.S.-centric view — loading up on Apple to the exclusion of any overseas tech stocks, or chasing the Snap IPO while ignoring the IPO market abroad — is hurting investors, say experts. It's leaving valuable growth stocks headquartered outside the country off the table. It's an investing prejudice that has led many investors to miss out on an overseas equities market that has outpaced the S&P 500 this year. In fact, the ETF to garner the most new assets this year through the end of March was the iShares Core MSCI Emerging Markets ETF (IEMG).

An employee inspects a wafer at the Infineon Technologies AG microchip and sensor manufacturing facility in Regensburg, Germany. Shares of the company are up 15 percent in 2017.
Krisztian Bocsi | Bloomberg | Getty Images
An employee inspects a wafer at the Infineon Technologies AG microchip and sensor manufacturing facility in Regensburg, Germany. Shares of the company are up 15 percent in 2017.

Two of the top international ETFs this year have an even more surprising overseas focus: international tech and foreign IPOs. Even when U.S. investors use tactical sector strategies, "they're overweighting the U.S.," said Todd Rosenbluth, director of ETF and mutual fund research at CFRA.

Take international technology. The SPDR S&P International Technology Sector ETF (IPK) has its biggest holding in Samsung, and for all of its missteps — from the notorious Note battery fire to a corruption scandal that took down South Korea's president — the stock has recovered. That has helped the international tech ETF to a 28 percent gain in the past year, through April 10, according to Morningstar data. But assets are small: only $29 million.

The US-centric Technology Select Sector SPDR ETF (XLK) has $17 billion (with a B) in assets. The U.S. tech ETF includes investor favorites like Microsoft, Apple and Facebook, which derive a significant amount of revenue from outside the United States. Some famed investors, such as Warren Buffett and Jack Bogle, have consistently maintained that getting overseas exposure through U.S.-based multinational corporations, held in indexes like the S&P 500, is enough.

"But investors are wrong in not looking internationally," Rosenbluth said.

Performance speaks for itself: The 28 percent gain in IPK beats the 23 percent return of XLK and compares favorably to the 22 percent gain in the past year for the PowerShares QQQ ETF (QQQ) that tracks the Nasdaq 100.

"The fund gives investors exposure to excellent technology companies that happen to be outside the U.S.," Rosenbluth said. "These are strong global brands." The fund's expense ratio of 40 basis points is also "pretty cheap," according to David Nadig, CEO of ETF.com, especially since it provides efficient exposure to other corners of the world.

Top 5 holdings in the International Technology ETF

  1. Samsung
  2. SAP
  3. ASML
  4. Canon
  5. Keyence

Rosenbluth said using U.S. and international technology portfolios together is the only way to get true global technology exposure. "Investors should think of the overall allocation," he said. "The global economy will be a tailwind for large-cap technology stocks like SAP and Samsung," he said. "And they're also more stable than smaller stocks."

Investing through a global portfolio doesn't bridge the gap nearly as much, since global technology funds tend to be heavily U.S.-weighted. The iShares Global Technology ETF (IXN) does own Samsung. But three-quarters of the fund's huge assets are invested in U.S. stocks like Apple, Facebook, Microsoft and Alphabet. Nadig described the portfolio as having diluted international exposure.

The rare IPO market that isn't overhyped

Outside the United States, IPOs are also notching double-digit gains — also unseen to most domestic investors. First Trust International IPO ETF (FPXI) is up over 13 percent so far this year, according to Morningstar data through April 10. First Trust's U.S.-focused IPO ETF, U.S. Equities Opportunities (FPX) is up 5.5 percent this year, according to Morningstar, and has near-$700 million in assets. The Renaissance IPO ETF (IPO), which is predominantly U.S. deals, is up 10 percent this year but has only $14 million in assets.

The First Trust International IPO ETF, meanwhile, is tiny — only $1.4 million in assets.

"Large and liquid IPOs are represented in the fund," said Ryan Issakainen, exchange-traded fund strategist at First Trust Portfolios. "It's a way to get exposure early on before institutions start buying."

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A primary reason to invest in an international IPO fund is the same as for a U.S.-focused one: access to stocks that indexes tend to drag their feet on adding, said Kathleen Smith, partner at Renaissance Capital. It took Facebook two years to make it into the S&P 500. Core international funds, such as MSCI EAFE and MSCI Emerging Markets Index ETFs, suffer from the same approach. Many investors take an approach that is the polar opposite, without even realizing it: Owning big-name tech stocks like Apple and index funds in which Apple is among the largest holdings.

The First Trust ETF is 61 percent exposed to Asia — with 33 percent specifically in emerging Asian stocks. Developed market Europe is 29 percent of the portfolio.Holdings, mostly in Japan and China, are big names like Alibaba and JD.com, along with lesser known stocks like Japan Post Holdings. Financials (40 percent) and consumer stocks (19 percent between cyclicals and defensives) are the biggest positions; technology is only 12 percent of the ETF, according to Morningstar data, which is below the benchmark and peer fund tech weighing.

Stocks are held for 1,000 days before they're sold. So they have potential for long-term growth. "IPOs can pop the first day and then have negative returns for the next year," Issakainen said.

Top 5 holdings in the First Trust International IPO ETF

  1. Alibaba
  2. Japan Post Holdings and Japan Post Bank
  3. Postal Savings Bank of China
  4. JD.com
  5. Recruit Holdings

Foreign IPO markets are generating high-quality companies, says Josef Schuster, founder at the financial services company IPOX Schuster in Chicago, which manages the index that First Trust's ETF is based on. In Europe, companies taken to market are often less speculative and there are no big defaults, he said, but added that China is a mixed bag.

Globally, IPOs have been off to a buoyant start this year, led by Asia, and marking the highest first-quarter number of share sales since before the financial crisis, according to EY.

"Good performance is here to stay due to stable company offerings and strong investor appetite," Schuster said. There's a large pipeline of deals, especially from Europe and China, supported by recent international IPO performance. For example, Siemens is expected to have a blockbuster IPO when it spins off its health care unit as Healthineers this year, which could be the biggest German offering of 2017.

Renaissance Capital's International IPO ETF (IPOS) flips the exposure — it is 61 percent developed European markets and 35 percent Asia, with that split evenly between Japan and emerging markets. The less risky profile has resulted in a lower gain than the First Trust international IPO ETF, but it is still up 9 percent this year, according to Morningstar. There's also a significant difference in the holding requirements for the international IPO ETFs: The First Trust ETF holds stocks for 1,000 days; the Renaissance ETF holds stocks for two years.

The Renaissance IPO has trailed the MSCI ACWI world index in the past one-year period, but year-to-date it and the First Trust international IPO ETF are beating the benchmark, according to Morningstar.

Smith said the U.S. IPO market also tends to be more volatile than the overseas IPO market, and investor fear of valuations, especially for tech stocks, can lead to dramatic selloffs. "There is no reason why the performance of the international IPO market can't accelerate," Smith said. "This is a conservative approach to owning an area that can be volatile," she said, noting that the two sectors weighted most heavily in the Renaissance ETF are financials and industrials.

Top 5 holdings in the Renaissance International IPO ETF

  1. Aena
  2. ABN Amro
  3. Japan Post Holdings and Japan Post Bank
  4. Worldpay
  5. Kyushu Railway

The Renaissance ETF is tiny, like First Trust's, at $2 million in assets. Smith said one reason the international IPO ETFs have struggled to gain assets in the lack of long-term track records. The Renaissance ETF will have a three-year track record in October, and three years of performance is considered a minimum for many investors to consider a fund.

Nadig and others worry that for all the opportunity to be had in overseas IPOs, the ETFs are too small. "Buyer beware because of small trades," he said. Rosenbluth added that the ETF's size makes it more at risk for being closed, though the companies held in the fund are liquid and will be around long-term.

Zacks Investment Research director of ETF Research Neena Mishra also worries that the fund's expense ratio of 70 basis points is too high (the Renaissance International IPO ETF has an expense ratio of 80 basis points). "IPOs are risky in general too," she said.

But Mishra acknowledged that the global economy is picking up. And that means good news for technology stocks and IPOs — no matter where they are based.

— By Constance Gustke, special to CNBC.com

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