Reopened borders have prompted US investors to look abroad for holidays and investment allocations alike. ETF flows show that, after peaking in early 2021, investor interest in international markets waned as subsequent waves of covid-19 infections led to longer lockdowns and delayed restarts. But that tide has turned: developed markets ex-U.S. ETF exposures saw flows outpace domestic ones by 60% in January, with the space gathering $12.3 billion over the course of the month.1 After its largest quarter of inflows in Q4 ‘21 since 2018, the iShares Core MSCI EAFE ETF (IEFA) gathered another $1.8 billion in January.2
In addition to restart dynamics, fundamental factors are also at play. Relative equity valuations between the U.S. and EAFE sit near all-time highs (i.e. U.S. stocks are more ‘expensive’ than developed markets outside of the US), making EAFE exposures look attractive to investors who may be looking to reinvest profits after a banner year for US equities.
Index composition matters as well. With central banks moving towards tighter monetary policy, the ‘growth’ factor has come under pressure as markets repriced rate expectations. Although we still see opportunity through differentiation amid the drawdown, the S&P 500 Index exhibits a natural bias towards the ‘growth’ factor with the information technology sector comprising approximately 28% of its holdings.3 In contrast, MSCI EAFE Index holds just a 9% weight in the information technology sector.4 Instead, its holdings are concentrated in value and cyclical exposures: the financial, industrial, consumer discretionary, and healthcare sectors make up over half of its holdings.
Investors looking to diversify away from growth and into value may do well to consider diversifying from away the US and into other developed markets.