VXUS Vs. VWO: The Differences And Which Is The Better Buy

Introduction

The Vanguard Total International Stock ETF (VXUS) and the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO), with aggregate AUM of over $115bn, are two of the most prominent investment options for those seeking exposure to terrains outside the US. In this article, I will pick out some of the key themes of these ETFs, and conclude with my preferred option at this juncture.

What are the key differences and similarities between VXUS and VWO?

If you’re looking for a more focused and concentrated international option, VWO should be your preferred bet, as it focuses entirely on emerging markets, and is heavily oriented towards Chinese and Taiwanese based stocks, which jointly account for over 51% of the total portfolio. Also consider that VWO covers a relatively smaller number of stocks (5,438) with the top-10 stocks having a more pronounced weight (~19% of the total portfolio).

With VXUS, things are a lot more diversified, as not only do you get access to emerging markets (~25% weight), you also get access to developed markets, with European-based stocks standing out in particular (~40% of the portfolio). The portfolio is also spread across a much wider group of names (7,896 stocks) and with limited concentration of the top holdings (the top-10 only account for 9% of the total holdings).

When it comes to sector-specific exposure, both ETFs gravitate towards the financial sector which enjoys the largest weight (19% exposure for VXUS and 21% exposure for VWO). The sectors where one can notice the greatest deviance are the industrials sector (VXUS’s exposure is 600bps higher than VWO’s exposure of only 7%), the healthcare sector (VXUS: 9%, VWO: 4%), and the tech sector (VXUS: 12%, VWO: 17%).

When it comes to the income angle of the two ETFs there’s not an awful lot to separate the two, with both ETFs offering yields within a range of 3.16%-3.32%. Both ETFs are also somewhat identical in growing their dividends with 3-year CAGRs of a little less than 8%.

Then, when it comes to cost-efficiency and stability, once again both ETFs are not poles apart. VXUS is available at an expense ratio of 0.07% whilst VWO is available at 0.08%. Both portfolios are also very stable, as exemplified by lowly annual portfolio turnover rates of 8% for VSUX and 9% for VWO (note that the asset class median is a lot higher at 25%).

How Have VWO And VXUS Performed?

The Vanguard Total International Stock ETF is the product with a shorter listing history (it came to the bourses only in Jan 2011, whilst VWO was around since March 2005) so our point of comparison starts from VXUS’s listing date. As you can see from the image below, the results are quite damning for VWO which has underperformed VXUS by almost 3x. Both ETFs have also significantly underperformed the SPY since VXUS’s listing date, which does make one wonder if there’s great merit in dabbling with international options, particularly during an era where risk aversion could be a lingering theme for the foreseeable future, and one is likely to see strong capital flows towards the dollar, given the US Fed’s aggressive positioning with policy rates.

Also do consider that at a time when the VIX has gained 57% on a YTD basis, VWO has posted the lowest returns, followed by VXUS and then SPY. This gives you some sense of how the market views these geographical regions whilst risk sentiment dwindles.

Regardless, to better understand these two ETFs, I’ve also attempted to look at the nuances of the risk-adjusted returns over the past 10 years. Of course, there’s no guarantee that we see similar stats over the next decade but at least it gives one a broader sense of the risk and returns characteristics of these two products.

The big picture takeaway from the image below is that the Vanguard FTSE Emerging Markets ETF is the riskier product of the two (given the degree of relative focus and concentration of markets, you would imagine volatility to be higher here) and it also doesn’t do a particularly great job of delivering excess returns for the level of risk it takes. Admittedly, both ETFs fail to do this, as the Sharpe ratios of both the products are less than 1.0 (for the uninitiated, the Sharpe ratio measures the excess returns that the ETF generates relative to the risk-free rate, after accounting for the standard deviation of the ETF). No doubt, VWO’s higher standard deviation figure (approx. 300bps difference between the two ETFs) makes it harder to generate excess returns. Also note that VWO’s peak to trough percentage figure is also more pronounced, highlighting the ferocity of selling associated with this product. Finally, also note the wide difference in the respective Sortino ratios (VXUS: 0.48, VWO: 0.31); this ratio considers the excess returns potential after incorporating downside deviations (the emphasis here is on harmful volatility rather than total volatility as measured by the Sharpe ratio). Once again, VXUS comes out on top.

To conclude this section, VXUS not only has the better return profile of the two ETFs, it also does a better job of mitigating some of its risks whilst attempting to deliver excess returns.

Closing thoughts- Is VXUS or VWO The Better Buy?

As covered in the previous section, based solely on the historical risk-adjusted return profile, one would be tempted to side with VXUS, but there are some other factors to consider, and this tilts things in favor of VWO.

Firstly, consider the general growth potential of the two markets that these ETFs track. We’re already four months into 2022, and I believe at current price levels the markets have priced in much of the headwinds that will likely linger this year. The IMF came out with its latest GDP outlook last week and whilst emerging markets saw a more pronounced cut in the FY22 GDP growth forecast (1% cut from the January update, vs -0.6% for advanced economies), do consider that the growth runway is still superior to advanced economies (EMs are expected to grow at 3.8% this year versus 3.3% for advanced economies). Crucially, also consider the much superior growth differential for 2023 where EMs will likely grow by 4.4%, whilst advanced economies will continue to slow for yet another year with growth declining to 2.4%.

When you have a much better growth canvass on offer, your equity constituents are also better placed to deliver much superior earnings growth over the long-term, and we can see that with VWO where the 5-year expected earnings growth rate works out to 14.3%; for VXUS this is 12.9%. Crucially also note that despite better long-term earnings potential, VWO’s constituents are available at cheaper forward P/E valuations; according to YCharts, VWO currently trades at 11.2x, whilst VXUS trades at 12.4x

I can also appreciate that a lot of investors are rather wary about Chinese-specific exposure (VWO has an inordinate weight towards that region) on account of its zero-COVID policy and leverage-related risks in the system, but you do have to wonder if things can get a lot worse from here. Latest reports show that cases in key regions have been slowing whilst the Chinese President also looks rather determined to arrest the slowdown and boost infra-related spending. The PBOC too has recently ramped up policy support for the economy. Also do consider that selling in Chinese stocks currently looks very overextended to the downside and could be due a reversal.

Besides, it’s not as if things are hunky-dory in VXUS’s focus markets; consider for instance what’s happening with VXUS’s top geographic market (Japan) where the weaker Yen continues to wreak havoc on the country’s trade deficit for yet another month, even as elevated commodity prices dampen the profit margins of Japanese corporates. Growth prospects there too continue to be very weak.

Finally, to conclude, I’d also like to highlight the mean-reversion opportunity for VWO, even as VXUS likely loses steam. Note that the relative strength ratio of VXUS, as a function of VWO is now trading towards the higher end of its long-term range, and there have been two separate instances – in 2014, and in 2018 – where this ratio had lost momentum at around current levels (which bodes well for VWO).

Thus, to conclude, VWO is the better buy at this juncture.