IEFA: Limited Exposure To Technology Sector Will Drag On Its Performance (BATS:IEFA)

ETF Overview

iShares Core MSCI EAFE ETF (BATS:IEFA) owns a portfolio of developed markets stocks from Europe, Australia, Asia, and the Far East. The fund has a high exposure to European stocks. This is beneficial in the near term as Europe’s economy appears to be improving. IEFA’s total return since its inception lagged the S&P 500 index. This was likely due to its lack of exposure to technology stocks than the S&P 500 index. This limited exposure will likely result in its underperformance to the S&P 500 index in the future. Therefore, we think investors may want to seek other funds instead.

Fund Analysis

IEFA has rebounded from the low in 2022, but has yet to surpass its peak set in 2021

Like many other funds, IEFA saw its fund price reach a cyclical low in October 2022. Fortunately, the market has turned bullish since this bottom, and IEFA delivered a total return of 45.2%. While this result was good, it still underperformed the S&P 500 index. As can be seen from the chart below, the S&P 500 index delivered a total return of 55.7%. IEFA’s current fund price of $72.10 per share has yet to surpass the peak of $78.20 per share reached on August 30, 2021. In contrast, the S&P 500 index has already surpassed the previous peak and setting new records in 2024.

IEFA is overweight in Europe

European stocks represent over 60% of IEFA’s total portfolio. As we know, Europe’s economy was hit hard by inflation in 2022. Fortunately, inflation has receded quickly in 2023 and the current inflation rate of 2.6% is much lower than the peak of 10.6% in October 2022.

Another evidence of Europe’s improving economy is the strengthening of Europe’s composite PMI. For reader’s information, PMI is a forward indicator that shows the strength of the economy. A reading above 50 usually means that the economy is heading towards expansion. On the other hand, a reading below 50 usually means that the economy may be heading towards contraction. As can be seen from the chart below, Euro Area Composite PMI has stabilized after reaching a bottom in October 2023. In fact, the composite PMI has improved from 46.5 in October 2023 to 52.2 in May 2024. Given that European stocks represent over 60% of IEFA’s portfolio, IEFA will likely continue to deliver positive returns in the months ahead. However, it is important to note that the current reading of 52.2 is only slightly above the neutral line of 50. Therefore, European stocks in IEFA’s stock may not be able to deliver very strong returns.

IEFA has underperformed the S&P 500 index

Below is a chart that compares IEFA to the S&P 500 index since IEFA’s inception in October 2012. As can be seen from the chart, IEFA delivered a total return of only 108% in the past 11 years. In contrast, the S&P 500 Index had a total return of 365% in the same period. Therefore, IEFA significantly underperformed the S&P 500 index.

Limited exposure to information technology sector

We think IEFA’s underperformance was due to its low exposure to fast growth sectors such as information technology sector. As can be seen from the chart below, information technology sector is only the 5th largest sector in IEFA’s portfolio and has a low representation of 9.4%. In contrast, information technology sector is the largest sector in the S&P 500 index and represents nearly one-third of the S&P 500 index.

Below is a chart that shows the consensus annual EPS growth rate by sector in the S&P 500 index. As can be seen, information technology’s expected growth rates of 29.3% in 2024 and 21.5% in 2025 clearly lead the growth rates of other sectors. Unfortunately, IEFA’s low exposure to information technology stocks means that its future performance will likely continue to lag the S&P 500 index.

Currency risk is real

IEFA’s fund price can be impacted by the strength of the U.S. dollar. A strengthening U.S. dollar will negatively impact IEFA’s fund price, and vice versa. As can be seen from the chart below, IEFA’s fund price has an inverse correlation to the strength of the U.S. dollar. Therefore, investors need to beware of currency risk.

Investor Takeaway

We are bullish about IEFA in the near-term as the economy in Europe appears to be improving, albeit at a slow pace. However, it is likely that IEFA will continue to underperform the S&P 500 index due to its lower exposure to technology stocks. Therefore, we think investors may want to seek other funds instead.