The Cheapest Foreign Index Trackers

Here's the lowdown on the simplest and cheapest way to invest in global stock markets.

Last week I wrote an article listing the ten cheapest index trackers following the UK stock market. Many of you were kind enough to use the comment feature for this piece and there were several requests for a similar article looking at non-UK index trackers.

So here it is. From the start I should say I've taken a slightly different approach here. As there are so many international markets, listing the ten cheapest wouldn't give you a decent spread of what's available for each region. So I decided to review some of the main funds out there and highlight what sort of charges you should expect to pay.

Which markets should you track?

The basic concept behind tracking a stock market is that you want to mimic its total return as closely as you can. This means you want to track as broad an index as possible. So in the UK, tracker purists would argue it's better to track the FTSE All-Share rather than the FTSE 100. The former accounts for 98% of the UK market by value, the latter just 80%.

Extending this argument further, you should really track the global stock market rather than just the UK. Indeed you could argue that index tracking makes even more sense when investing abroad. Given that the average fund manager can't outperform their own domestic market, the chance of them outperforming in an unfamiliar foreign territory is even slimmer!

So how important is the UK market internationally? It's one of the largest stock markets but it only accounts for around 6% of total global market capitalisation as the table below illustrates.

Source: World Federation of Exchanges

So to invest as broadly as possible, we could argue that we want to put around 40% of our money in the Americas and 30% each in Europe/Africa and the Asia/Pacific region.

There is a second approach to foreign trackers where people aim to cherry pick particular areas of the global economy that they think are going to do well and then use index trackers as a low-cost route of investing in them. For example, someone might want to invest in the BRIC countries (Brazil, Russia, India and China) to take advantage of their predicted rise up the international economic pecking order.

Each of these two approaches has its merits but I think it's important to decide which you want to follow before choosing any foreign index trackers. It's also worth investigating the detail behind the each of the indices you decide to track. Ideally you want an index that tracks as much as the country or region's market value as possible.

So what's on offer when it comes to international index tracking? Let's look at each type of investment fund in turn.

Unit trusts and OEICs

There's not a huge amount of choice here with around half the number of foreign trackers compared to UK trackers. The two cheapest are HSBC's Japan Index Fund and the M&G European Index tracker with total expense ratios of 0.58% and 0.71% respectively.

These are followed by Legal & General which has four funds following the US, European, Pacific and Japanese markets, each of which has a total expense ratio of around 0.8%. L&G also does a Global 100 Index fund which has a total expense ratio of 1%.

Investment trusts

As far as I am aware there is only one fund that qualifies here and that is the Edinburgh US Tracker trust. It has a very commendable total expense ratio of 0.3% though and follows the S&P 500, which is generally accepted to be the best measure of the US market.

ETFs

If you want a foreign tracker, exchange traded funds provide the broadest selection and the best value for money. Let's look at the funds offered by the three largest ETF providers.

With iShares expect to pay a total expense ratio of 0.4% to track the developed markets of the US, Europe or Japan. However, they do have one European fund tracking the DJ Euro Stoxx 50 which currently has a total expense ratio of 0.15%. For emerging economies, total expense ratios are around 0.75%. Although they have a BRIC tracker, iShares currently doesn't seem to offer an Indian fund.

Lyxor, backed by Societe Generale, charges around 0.35% for US funds but doesn't seem to offer a mainstream European fund. Other funds vary from 0.5% for Japan, 0.65% for Brazil, Russia and China and 0.85% for India.  

Deutsche Bank, with its db x-trackers, is the third major ETF player. US and European funds are 0.3% while those following Japan, Brazil, Russia and China charge the same as Lyxor. Like iShares it offers no Indian fund but it does have global ex-UK tracker charging 0.4% and another DJ Euro Stoxx 50 fund at just 0.15%.

What's the verdict?

Just two years ago the choice of international index trackers was fairly poor. But now there are several funds that allow us to invest in the US and Europe for just 0.3%-0.4% a year, a similar cost to the cheapest UK trackers. Investing more exotically is still a little bit more expensive, at around double this level. Costs here should come down in future but they are still low enough now to make index trackers an attractive way to invest internationally.

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