International Index Funds Gain Appeal as Global Equities Outpace S&P 500

The divergence between U.S. and international stock markets has reached levels not seen in three decades. As international index funds attract increasing investor attention, the performance gap tells a compelling story about valuation disparities, currency movements, and shifting market dynamics under recent policy changes. Understanding this shift is critical for investors evaluating where to deploy capital.

Why Global Markets Are Leaving U.S. Stocks Behind

The S&P 500 has advanced less than 1% year to date, while the MSCI ACWI ex U.S. Index—the primary international stock market benchmark—has returned 10%. This represents the widest performance gap at this point in any year since 1995, according to macro research analysts at Charles Schwab.

The underperformance accelerated dramatically since January 2025. The MSCI ACWI ex U.S. Index surged 40%, compared to just 15% for the S&P 500—a stunning 25 percentage point gap that marks a rare divergence in recent market history.

Valuation disparities drive the divergence. Global stocks trade at a significant discount to their U.S. counterparts. The forward price-to-earnings multiple for the MSCI ACWI ex U.S. Index is roughly 32% below that of the S&P 500. While American equities have typically commanded a premium to international shares over the past two decades, the current gap is nearly double historical averages, according to JPMorgan Chase analysis. This makes international index funds particularly attractive on a relative value basis.

Currency movements amplified international returns. The U.S. Dollar Index has declined 10% under current policy conditions, as sweeping tariff proposals, rising federal debt, and repeated attacks on the Federal Reserve stoked concerns about economic growth. A weakening currency typically benefits international stock returns when converted back to dollars. For U.S. investors holding international index funds, this currency tailwind provided substantial additional gains.

Comparing International Index Funds: Where Your Money Can Go

Investors seeking exposure to global equities have two dominant options: the Vanguard FTSE Emerging Markets ETF (VWO) and the iShares MSCI Emerging Markets ETF (EEM). While international index funds of this type share similar holdings in major markets like China, Taiwan, India, and Brazil, meaningful differences exist.

South Korea exposure creates a performance divergence. The iShares fund includes significant allocations to Samsung and SK Hynix, the world’s largest memory chip manufacturers. These companies have benefited enormously from artificial intelligence demand. Over the past year, the iShares fund returned 42%, while the Vanguard alternative delivered 30%. However, this performance advantage narrows when examining longer time horizons.

Cost structures matter more than many investors realize. The iShares fund carries an expense ratio of 0.72%, while Vanguard’s stands at just 0.06%. Over five-year periods, the lower fee structure of the Vanguard international index funds has offset the superior short-term performance of the iShares product, resulting in nearly identical cumulative returns. For cost-conscious investors, Vanguard’s approach offers compelling value, while those betting on continued Korean semiconductor strength might favor iShares.

Emerging Markets Paint a Stronger Picture Over the Next Decade

Goldman Sachs analysts, led by Peter Oppenheimer, project notably divergent returns across major stock markets during the coming decade. While the S&P 500 is forecast to compound at 6.5% annually, international index funds offer more attractive prospects:

• Europe: 7.5% annually
• Japan: 12% annually
• Asia (excluding Japan): 12.6% annually
• Emerging Markets: 12.8% annually

Emerging market equities, accessible through international index funds like VWO and EEM, stand out for their substantial outperformance potential. These forecasts reflect expectations that U.S. valuations will moderate while growth accelerates in undervalued international markets, particularly as emerging economies benefit from technological diffusion and demographic tailwinds.

Making Your Investment Decision: International Index Funds vs. Domestic Focus

The case for international index funds has strengthened materially, yet the argument for maintaining meaningful U.S. equity exposure remains valid. Technological innovation continues to provide substantial long-term advantages to American markets. The U.S. remains the undisputed leader in artificial intelligence, biotechnology, and numerous other growth sectors that tend to drive returns over multi-decade periods.

A balanced approach suggests keeping the majority of portfolio assets in U.S. equities while using international index funds to gain meaningful diversification benefits and capture valuation opportunities abroad. History demonstrates that during periods of U.S. outperformance, investors often regret their international allocations, while the opposite holds true during international outperformance phases.

The current window may represent exactly such a moment—when international index funds offer compelling risk-adjusted returns relative to domestic alternatives. Investors should evaluate their individual circumstances, time horizons, and risk tolerance before shifting significant capital toward international equities or international index funds specifically.