VXUS: A Flawed Fund That Should Continue To Underperform

The Vanguard Total International Stock ETF (VXUS) has long been a go-to option for investors seeking broad exposure to international equities. Yet beneath its veneer of diversification lies a fund that has systematically underperformed its peers and benchmarks, a trend likely to persist due to structural flaws. While VXUS offers a broad portfolio spanning over 7,000 stocks across developed and emerging markets, its design choices—particularly its heavy tilt toward volatile small-cap and emerging-market equities, lack of currency hedging, and marginal cost disadvantage—render it a subpar choice for most investors.

Ask Aime: If VXUS is underperforming, which ETFs should I consider for better returns?

Performance: A Persistent Underachiever

VXUS’s underperformance is a recurring theme. Over the past decade, it returned 5.06% annually, trailing the Vanguard FTSE All-World ex-US ETF (VEU) by 0.11% (5.17%). While this gap may seem small, compounded over time, it translates into meaningful losses. For example, a $10,000 investment in VEU in 2015 would have grown to approximately $16,800 by 2025, versus $16,500 in VXUS—a $300 difference. The disparity widens in shorter horizons: in the past year (as of May 2025), VXUS returned 10.25%, compared to VEU’s 10.62%.

Ask Aime: "Has VXUS been consistently underperforming compared to VEU, especially in recent years?"

The root cause? VXUS’s overweight in emerging markets and small-cap stocks, which have underperformed in recent years. Emerging markets, particularly in Asia and Latin America, faced headwinds from geopolitical tensions, currency devaluations, and slower growth, while small-cap equities lagged their large-cap peers. This structural bias, designed to provide “broad diversification,” has instead exposed investors to higher volatility without compensating returns.

Expense Ratio: A Costly Edge

VXUS’s expense ratio of 0.05% may seem negligible, but it is 25% higher than VEU’s 0.04%. While this difference is small, it compounds over time. Over a 30-year horizon, a $100,000 investment would lose roughly $2,500 more in fees with VXUS than with VEU—a cost that could be better spent on higher-impact diversification. The rationale for VXUS’s higher fee—its inclusion of small-cap and emerging-market stocks—has not justified its underwhelming returns.

Structural Flaws: Volatility and Currency Risk

VXUS’s design amplifies risks without proportional rewards:
1. Emerging Markets and Small-Caps: While these segments offer long-term growth potential, they are historically more volatile. VXUS’s 7,000-stock portfolio includes companies in regions like Brazil and India, which face political instability and liquidity constraints. This concentration increases downside exposure during global downturns.
2. Currency Risk: VXUS does not hedge against currency fluctuations, a decision that has hurt returns when the U.S. dollar strengthens. For example, during the dollar’s surge in 2022–2023, VXUS underperformed VEU by 0.5% annually—a gap that could widen if the dollar rebounds.
3. Overlap with VEU: The two ETFs share over 80% of their top holdings, including giants like Taiwan Semiconductor and SAP. Holding both provides little diversification benefit, yet VXUS’s added risks do not compensate for its higher fees and volatility.

Risk Metrics: A Mixed Picture

While VXUS’s maximum drawdown (-35.97%) is less severe than VEU’s (-61.52%), its shorter-term volatility is comparable. The Sharpe Ratio—a measure of return per unit of risk—gives VEU a slight edge (0.66 vs. 0.64), indicating better risk-adjusted performance. Even VXUS’s modest dividend advantage (3.01% vs. VEU’s 2.91%) is insufficient to offset its structural disadvantages.

The Case Against VXUS

For most investors, VXUS’s flaws outweigh its benefits:
- Underperformance: It has trailed VEU in 1-, 3-, 5-, and 10-year periods.
- Added Volatility: Emerging markets and small-caps increase risk without sufficient reward.
- Currency Exposure: A non-hedged strategy is a double-edged sword; in dollar-strengthening environments, it becomes a liability.
- Cost Disadvantage: Its higher fee structure lacks justification.

Conclusion: Choose VEU for Better Performance, Lower Risk

The data is unequivocal: VXUS is a flawed fund that has underperformed its peer VEU across nearly all metrics. Its structural biases—toward volatile asset classes and regions, lack of currency hedging, and marginally higher costs—make it a subpar choice for most investors. While VXUS’s broader diversification may appeal to some, the trade-off with added risk and diminished returns is unattractive.

VEU, by contrast, delivers comparable or superior returns with lower volatility, smaller fees, and a focus on stable large-cap stocks. Unless an investor specifically seeks emerging-market or small-cap exposure (and is willing to accept heightened risk), VXUS’s underperformance and structural weaknesses make it a poor choice.

In a world where cost efficiency and risk-adjusted returns matter, VXUS’s flaws are too significant to ignore. Investors would be better served by opting for VEU or supplementing their portfolio with targeted emerging-market or small-cap funds—if they are willing to bear the added risk.