What Is the EAFE Index? Definition, Countries Included, and Use As an Index

The commentary which follows relates to pros and cons of the EAFE Index as below, although it can also be argued in favour or against exchange-traded funds (ETFs) or mutual funds designed to track this index’s performance.

Advantages

Diversification: the EAFE Index covers 21 countries and more than 700 companies, so you could easily own a well-diversified international portfolio by buying an ETF or a mutual fund that attempts to replicate the index with a single purchase.

Less volatility: The EAFE Index has significantly less volatility than a few other international indices, largely because it captures companies in developed countries while other indices capture developed, emerging market and developing market countries. Consequently, investments that track it will, on average, have less volatile performance.

Lower costs: Securities designed to track the index – matched bets, if you like – will be passively managed. They’ll cost investors less than actively managed ETFs and mutual funds.

Disadvantages

Lack of country exposure: China, India, Brazil and Russia are not included in EAFE; any investments tracking it will also exclude them and possibly some of their most attractive return opportunities.

Less growth potential: EAFE Index tracks only 21 companies within developed countries. This excludes companies in emerging and developing countries that may have potential for growth and positive returns.

Investments according to market cap: Since the EAFE Index weights its investments according to market capitalisation, funds follow the practice. This would concentrate the fund’s investments heavily in the companies of several countries. That might mean missing out on potential return.

Pros

Diversification

Less volatility

Lower costs

EAFE Index As a Benchmark

The EAFE index is also frequently used as an institutional benchmark for the international developed equity market. It provides a way for institutional investors and asset managers to measure the performance of a fund. A fund can be said to be outperforming its benchmark when its rate of return exceeds that of the EAFE Index. Conversely, it is underperforming if its rate of return falls short of that of the EAFE Index. Asset managers are charged with the responsibility of exceeding a fund’s benchmark; a manager who trailed the average return of the EAFE Index for a year would be hard-pressed to keep their job.

Because stocks from EAFE represent an increased level of diversification for investors who want to go beyond the borders of US and Canadian equity markets, that’s where many of them end up: in investors’ portfolios. They can be bought via index-tracking financial products – for example ETFs.

An ETF that tracks the performance of the EAFE Index is the iShares MSCI EAFE ETF (ticker symbol: EFA). Its net assets are $49 billion. Its expense ratio is 0.33%, as of February 2023. Two other ETFs mirroring the EAFE Index are the iShares Core MSCI EAFE (IEFA) and the iShares MSCI EAFE Small-Cap (SCZ) ETFs.

EAFE vs. ACWI

The chart above shows the chart of MSCI ACWI (All Country World Index) which reflects the market performance. The ACWI holds around 2933 companies in 47 countries-23 developed countries and 24 emerging economies. This benchmark index can be understood as a transparent instrument which can be monitored. It allows investors to take over investment opportunities that could be potentially profitable in several capital markets all over the world.