Why VSS Could Be the Most Overlooked Long-Term Diversifier in International Investing

It might not be commonly known, but international stocks have outperformed their U.S. counterparts for more than a year now. While U.S. markets have dealt with tariffs, high stock valuations, a sputtering economy, and now a war in Iran, international stocks and international ETFs have been a viable alternative for investors.

Over the past 12 months, the MSCI ACWI ex US Index, which includes about 2,900 large- and mid-cap stocks from developed and emerging markets, has a total return of about 40%. Its U.S. counterpart, the Russell 3000, is up about 36%. Year to date, the international index is up about 11%, while the Russell 3000 has gained about 4% as of April 20.

Over the past 16 months (going back to Jan. 1, 2025), the MSCI ACWI ex US Index has outperformed the Russell 3000 by 18 percentage points, with a return of 35% compared to 17% for the Russell 3000.

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Investors are diversifying away from overvalued U.S. stocks. A weakening U.S. dollar and significant infrastructure and defense spending in some major foreign markets have also contributed to the outperformance, along with some favorable monetary and fiscal policy changes in key markets.

Furthermore, the AI boom has gone beyond U.S. borders to international and emerging markets, where investors have found cheaper AI stocks.

Why the VSS ETF stands out

Generally speaking, international stocks and ETFs have been great diversifiers, particularly in recent years. The outperformance could continue, at least according to some experts. Earlier this year, strategists at Vanguard said they expect international stocks to outperform U.S. stocks over the next decade, mainly due to the massive valuation gap between the two and AI transformations hitting international and emerging markets.

If you are seeking outperformance in an international ETF, a good place to look is the Vanguard FTSE All-World ex-US Small Cap Index Fund (NYSEMKT: VSS).

Small-caps in general have been overshadowed by large-caps through the bull market, but this ETF caught the attention of many investors with its stellar returns. In 2025, the ETF returned 30% on a total return basis, with dividends reinvested, while the Vanguard Russell 2000 ETF (NASDAQ: VTWO), its U.S. counterpart, returned about 13%. This year (through April 20), it is up about 12%, roughly the same as the U.S. small-cap counterpart.

Diversifying outside the U.S. is always a good idea, but it is even more critical now with U.S. markets navigating economic and geopolitical uncertainty and still-high valuations.

Small-caps, particularly those outside the U.S., are poised for continued outperformance due to their lower relative valuations, the broadening out of the AI boom, and favorable fiscal policies and increased infrastructure spending.

Small-caps are often overlooked given their recent long-term underperformance relative to large-caps. But the VSS ETF's performance shows they should be on your radar.

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard FTSE All-World ex-US Small-Cap ETF. The Motley Fool has a disclosure policy.