Quest for Diversification: Should U.S. Investors Venture into European ETFs?

Abstract

The recent explosion of country- and region-specific exchange-traded funds (ETFs) has given rise to some basic questions on how to select the right ETF for a specific purpose. ETFs gained tremendous popularity with individual investors and money managers due to their ability to provide investors with diversification at a very low cost of ownership. But just as mutual funds reached a saturation point, have ETFs also reached this point where few, if any, additional ETFs are providing diversification benefits? The question to be answered in the study is whether European ETFs with higher diversification benefits require a cost of ownership premium relative to other ETFs. Using a sample of European country-specific ETFs and continental Europe ETFs, the author finds that ETFs with high expense ratios and high turnover provided a positive and significant diversification benefit to investors. European ETFs with higher fees and turnover experienced lower levels of return correlation with the SPY over the last five years. Unfortunately, these higher expense ratios and turnover levels were not significant in explaining ETF performance, leaving investors with the difficult question of where do European ETFs fit for an investor seeking diversification.