Wilting ETF Returns

With plenty of cheerleading from Wall Street, Americans have grown accustomed to pouring money into foreign markets from Brazil to New Zealand. But some customers are finding drawbacks in a popular foreign investment -- exchange-traded funds that own the stocks or bonds of just one country. It turns out that putting too many eggs in one basket can still be a risky move, even when the basket is woven overseas.

The ETF industry now offers 73 single-country funds, almost double the number from two years ago, with $47 billion under management. But having a thriving economy doesn't mean that a country's ETF won't get crushed. One problem: Very few of these ETFs use hedging strategies to compensate for the movements of local currency. Those fluctuations can clobber a U.S. investor's returns, especially when a currency drops in value against the dollar. Swiss bank UBS reports that from 2000 to 2010, while Taiwan's economy had an average annual growth rate of 4.2 percent, its stock market barely budged in U.S. dollar terms, because of currency moves. Angus Shillington, director of international equities at Van Eck Global, a brokerage that offers single-country ETFs, says predicting which countries' markets will avoid such problems "is more difficult than picking stocks."

ETF defenders respond that hedging would make their products more expensive. Money managers who use the single-country products say that over the long term, currency fluctuations tend to even out. Charles Sizemore, a Dallas investment adviser, says he's seen European ETFs benefit recently from the falling euro: "The lack of hedging is not necessarily a bad thing."

Pros say the best way to dodge trouble is usually to diversify, spreading money across multiple countries at once. Investors can choose several single-country funds, says Tom Lydon, a financial planner in Irvine, Calif., who uses ETFs in client portfolios; simpler still, they can buy ETFs that invest in all the countries in one region or track broader emerging-market indexes.