What Is MSCI EAFE?

Definitions & Examples of How to Use MSCI EAFE

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The MSCI EAFE is a popular stock market index that's commonly used as a benchmark for major international equity markets. Large and mid-cap companies from developed countries worldwide, excluding the U.S. and Canada, are included in the index.

Keep reading to learn about the countries included in this index, along with some benefits and drawbacks.

What Is MSCI EAFE?

MSCI EAFE is a stock index, originally launched in 1986, that allows investors to easily track equities in various developed markets around the world. MSCI and EAFE are both acronyms. MSCI stands for Morgan Stanley Capital International, which is a financial institution that provides equity, fixed income, and hedge fund stock market indexes and portfolio analysis tools. EAFE stands for Europe, “Australasia” (Australia & New Zealand), and the Far East (East Asia). Those are the markets included in this index. As of July 2020, MSCI EAFE tracks equities in 21 countries.

MSCI EAFE covers about 85% of the free float-adjusted market capitalization in each country that it targets.

How Does MSCI EAFE Work?

The holdings in MSCI EAFE are weighted according to market capitalization. In other words, larger companies receive a higher percentage of fund investment.

The MSCI EAFE index is widely used in the investment management community as the standard for judging the performance of foreign mutual funds and pension accounts. Managers of these funds compare their own performance to the MSCI EAFE to determine whether they are providing value to clients or not.

Where to Find Data on MSCI EAFE

Performance data for EAFE and many other global indices is available for free on the MSCI website. This data includes top holdings, sector weighting, country weights, and other data that international investors can use to ensure that their overall portfolio is properly diversified. Investors can also find information regarding valuation metrics and other fundamentals, as well as risk characteristics that may be important to consider when building a portfolio.

Investing in the International Stock Index

There are many different exchange-traded funds (ETFs) focused on the MSCI EAFE index. Investors looking for broad exposure to ex-U.S. markets may want to consider these funds to add international diversification to their portfolios.

Some popular MSCI EAFE ETFs include:

  • iShares MSCI EAFE ETF (EFA)
  • iShares Core MSCI EAFE ETF (IEFA)

Investors should carefully consider the expense ratios, liquidity, and other characteristics of these funds before investing in them. It's also important to ensure you're buying the proper product. There are leveraged and inverse ETFs that track the MSCI EAFE, but these are advanced investment products that investors should approach with caution.

Pros and Cons of MSCI EAFE

Pros
  • Low fees

  • Low volatility

  • Broad diversification

Cons
  • Many countries excluded

  • Market-cap weighting concentrates investments

  • Potentially fewer growth opportunities

Pros Explained

  • Low fees: EAFE is a passively managed basket of stocks, similar to the S&P 500 index. Mutual funds and ETFs built around passively managed indexes typically come with lower fees. That's because a fund manager doesn't have to spend time actively managing the fund's holdings.
  • Low volatility: The EAFE index tends to have less volatility than other international indexes, especially ones like MSCI BRIC, which tracks emerging markets. For those looking for international exposure, EAFE is a relatively less-volatile way of doing so.
  • Broad diversification: EAFE allows investors to easily diversify their portfolio. Investors can individually replicate the index in their portfolio, or they can simply buy a mutual fund or ETF that replicates the index. Either way, the investor gains broad exposure to 21 different countries.

Cons Explained

  • Many countries excluded: While the inclusion of 21 countries is broader than many indexes, many countries are excluded. Countries like Brazil, Russia, India, and China all have massive economies, but those economies are completely excluded from this index.
  • Market-cap weighting concentrates investments: It's common for indexes to be weighted by market capitalization, but there are downsides to that strategy. By including more of the largest countries, you concentrate your investments in just a handful of countries, like the UK and Japan.
  • Potentially fewer growth opportunities: While the exclusion of emerging markets and developing countries helps make this index less volatile than others, that means there may be fewer growth opportunities as well. A developing country has a lot of room to grow, while developed countries have already experienced periods of rapid growth.

Key Takeaways

  • The MSCI EAFE is a stock market index that encompasses Europe, Australia, New Zealand, and East Asian countries.
  • MSCI stands for Morgan Stanley Capital International, a financial institution focused on stock market indexes. EAFE stands for Europe, Australasia, and the Far East.
  • There are 21 countries included in MSCI EAFE.
  • This index is weighted by market capitalization.

Article Sources

  1. Morgan Stanley Capital International. "MSCI EAFE Index (USD)." Accessed Aug. 13, 2020.