The Vanguard MSCI Index International Shares ETF (ASX: VGS) is having a bad year in 2022. Don't forget that it finished up in the COVID-hit year of 2020.
So far in 2022, the Vanguard MSCI Index International Shares ETF is down by close to 20%. Ouch.
For an exchange-traded fund (ETF) that offers a lot of diversification with exposure to different countries, currencies and industries, that's a big fall.
Why is the Vanguard MSCI Index International Shares ETF down so much? It comes down to what's going on with the holdings inside the ETF.
What affects an ETF's performance?
An ETF is a fund that enables us to buy a group of assets with one investment. With just one name an investor can get exposure to dozens, hundreds or even thousands of businesses.
The performance of those businesses then dictates the performance of the ETF.
For example, if business A is 10% of the portfolio and goes up 20% then this would add 2% to the portfolio's return. If business B is 5% of the portfolio and goes down 10% then this would detract 0.5% from the ETF's portfolio return. And so on.
If the overall underlying portfolio goes down in value, taking into account their position sizing in the ETF, then the price of the ETF goes down too.
What is happening to the Vanguard MSCI Index International Shares ETF?
This index is invested in over 1,400 businesses. So, it has plenty of diversification. But, if most of them fall at the same time, then investors will suffer from price declines.
What's difficult at the moment is that more than 70% of the ETF's weighting is to businesses in the United States.
A number of the US companies in the portfolio are tech shares or tech-related. The biggest five positions in the Vanguard Index International Shares ETF at the end of August were Apple, Microsoft, Alphabet, Amazon and Tesla.
Inflation in the US has been particularly strong. Central bankers don't want this situation to continue, it's not helpful for economic stability. To fight this, the US Federal Reserve is increasing the interest rate to take some heat out of the economy.
This has been painful for the US share market. Just look at the S&P 500 Index (SP: .INX), which is down by 25% in 2022. This is a popular and widely-followed index of 500 US-listed businesses.
So, the US portion of the ETF's portfolio (which accounts for more than two-thirds of the allocation) is having a rough time. The rest of the global share market is seeing volatility as well.
Why do interest rates matter?
I think that one of the best explainers about interest rate impacts on assets comes from legendary investor Warren Buffett:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature… its intrinsic valuation is 100% sensitive to interest rates.
Time will tell when the Vanguard MSCI Index International Shares ETF price hits a bottom.
