ETFs: The New Way to Profit From Global Growth

With ETFs or exchange-traded funds, it pays to go global.

Over the past several years, international ETFs have been one of the main stars in the investment arena. Indeed, these international funds have eclipsed virtually every domestic benchmark, according several publications that follow the sector.

As one great example, consider the iShares MSCI Emerging Market Index (Amex: EEM), considered a bellwether of international ETFs. Since its debut in April 2003, EEM is up 224% ¬ or nearly four times the 63% gain notched by the U.S.-focused Standard & Poor's 500 index.

Market Beating Returns With ETFs

Most ETFs haven't been around all that long. But the best ones have already forged an enviable record and help show why it's important for investors to look abroad for profit opportunities.

Indeed, all three if these closely watched domestic U.S. stock indexes have been thoroughly trounced by the top three international ETFs. We already mentioned that the S&P 500 is up about 63% since April 2003. During that same period, the tech-heavy Nasdaq has climbed 79% while the blue-chip dominated Dow Jones Industrial Average has advanced 51%.

The other top ETFs have left these results in the dust.

• The well-diversified iShares EAFE Index (Amex: EFA) – the highest-volume international ETF after iShares Japan – has more than doubled, notching a return of 144%. EFA is an index fund that invests in Europe, Asia, Australia and Africa.

• As for the afore-mentioned iShares Japan (Amex: EWJ): Well, it's up 138% during that same stretch.

While it's usually prudent to avoid the most-recent hot performers – and while analysts claim many of the international ETFs are currently overbought – the ultra-strong long-term growth forecasts for international investments makes it prudent to keep these in mind.

As always, to really understand the issue, we must take a closer look at some investment money flow statistics.

The Money Flows ‘Tale of the Tape'

Of the $124 billion that investors poured into mutual funds last year, $110 billion went into international investments. That's almost 90%.

ETFs have been the big beneficiary. While mutual funds of all types have seen their assets climb by a total of 50% over the past five years, ETFs holdings have soared fivefold during the same period, according to a recent report by The Wall Street Journal.

Expect the surging interest in overseas investing to continue: From a base of $118 trillion at the end of 2003, the worldwide value of financial assets will soar to nearly $230 trillion by the end of this decade, McKinsey Global Institute predicted in a recent report.

Fast-growing markets in Asia – and to a lesser extent Europe – will be leading the charge, says McKinsey, the think-tank affiliate of the esteemed consulting firm.

Indeed, between 1993 and 2005, financial assets in these markets grew at a compounded annual rate of 16.4 percent – besting the European Union (9.1%), the United States and the United Kingdom (both 8.5%), and Japan (4.7%).

These newly capitalist economies now account for about $15 trillion of the world's total financial assets. That's only 11% of the total, but is more than double the $7 trillion of a decade ago, McKinsey said.

And yet these trillions in additional homegrown financial assets have yet to really fuel stock-market growth in these new markets. Just look at China, which just over a year ago had $5 trillion in financial assets. The kicker: Nearly three quarters of that money was still being held as bank deposits.

As investors in countries such as China see their incomes advance, they'll have greater and greater confidence in their financial system – and will have a growing desire to benefit, as well. Cash will leave bank accounts and find its way into stocks, bonds and mutual funds, fueling big advances in the key market indices that many of these ETFs mimic.

That's especially huge in China: In 2003, more than 60% of its $5.1 trillion in financial assets were bank deposits, McKinsey found. When that cash is withdrawn from banks and directed into stocks, it's precisely the kind of money flow that could spark a major advance in China stock prices.

In the United States, by contrast, only about 20% of financial assets are held as bank deposits, the McKinsey report shows.

ETFs Trump Mutual Funds

As they proliferate and are refined, ETFs are emerging as the best way to profit from global growth, several recently released reports conclude. Because they track an index, but can be traded like a stock, ETFs offer the diversification of conventional mutual funds – but with a liquidity that can make them much safer during volatiles periods.

And since they "bundle" together the securities that make up an index, the transaction and operating costs of ETFs are a fraction of a mutual fund that pursues an active management strategy.

With some of these markets, ETFs represent the only way possible for U.S. investors to benefit from the high rates of growth: The companies aren't registered with U.S. securities regulators, meaning American investors can't purchase the individual stocks, and no good U.S.-based mutual fund exists.