How Easy Is It to Beat EAFE?

Many investors who sought the benefits of diversification by having some international equity exposure have been disappointed over the past several years. Over the last decade, for example, developed world stocks, as measured by the MSCI EAFE Index, returned just 1.7% on an annualized basis, lagging the S&P 500 Index, which returned 7.5% from August 31, 2006, to August 31, 2016. On a cumulative basis, that differential summed up to nearly 90% over 10 years. This return represented one of the worst 10-year periods for the MSCI EAFE Index in the past 30 years. The chart below shows 10-year rolling returns for the MSCI EAFE Index for all the 10-year periods going back to the one that ended in March 1996. The average 10-year return for EAFE over that period (denoted by the orange bar) was 5.5%. The 1.7% return over the last decade ranked it in the bottom decile of EAFE’s 10-year returns—meaning 90% of the other observations generated higher returns. If you believe in reversion to the mean, investing after a period of historic underperformance may actually represent an opportune entry point for developed world investors.   10-Year Rolling Returns of the MSCI EAFE Index, March 1996–August 2016 Given the MSCI EAFE’s paltry returns during this period, it might seems as though it must have been easy for most actively managed international funds to beat EAFE over this period. But the truth is, of the 717 Foreign Value, Foreign Blend and Foreign Growth funds that Morningstar tracks, the MSCI EAFE Index actually outperformed 51% of them. So even during a period when EAFE generated low-single-digit returns that ranked in its lower decile, roughly one in two foreign funds still did not outperform the benchmark. This is one of the reasons many investors are increasingly looking to international exchange-traded funds (ETFs) as an alternative to actively managed mutual funds. One ETF that did beat EAFE over the last decade was WisdomTree’s core product in this category: the WisdomTree International Equity Fund (DWM). DWM tracks an unhedged WisdomTree Index that includes virtually all the investable dividend-paying stocks in the developed world, outside the U.S. and Canada. There are typically more than 2,000 such dividend-paying stocks. Each June, WisdomTree weights each company in this Index based on the dollar value of the cash dividends it pays. After fees and expenses, DWM outperformed the MSCI EAFE Index by 45 basis points (bps) per year, beating 92% of its peers in the Foreign Large Value category tracked by Morningstar over that 10-year period. If we expand the universe to the group of 717 Large-Cap Value, Blend and Growth funds, DWM beat 63% of them in the 10 years ending June 2016, with its underlying WisdomTree Index beating two-thirds of the competition over the last decade. WisdomTree’s dividend-weighted approach was able to achieve these results despite the fact that the MSCI EAFE Growth Index outperformed the MSCI EAFE Value Index by 266 bps per year over this period. (For standardized returns of DWM, click here.)     Conclusion Returns for the EAFE Index over the past decade were low in absolute terms and low relative to its own history. That 10-year underperformance relative to the S&P 500 Index may actually be signaling that this is a good time to take a fresh look at international stocks. For investors interested in a dividend-weighted ETF that has a history of generating both more dividend income and greater total returns than the EAFE Index, click for more information on DWM, the WisdomTree International Equity Fund.     Unless otherwise noted, data source is Bloomberg, as of 8/31/2016.