The developments of the last several years have highlighted the growing gap between the developed and emerging markets of the world. Advanced economies in North America, Europe, and Asia face mounting debt burdens and the prospect of a prolonged stretch of low economic growth. Meanwhile, many emerging markets have raced ahead, boasting blistering GDP growth and impressive fiscal health. So it is by no means surprising that many U.S. investors have shifted their portfolios more heavily towards emerging markets, embracing this asset class as a source of greater long-term growth potential and perhaps lower risk as well.
As interest in emerging markets has soared, more and more investors have embraced ETFs as a way to access this increasingly important asset class; the combination of emerging markets and the transparency and efficiencies of the exchange-traded structure has obvious appeal to anyone building a long-term portfolio.
By far the two most popular products in the Emerging Markets ETFdb Category are both linked to the MSCI Emerging Markets Index: EEM and VWO. But thanks to ongoing innovation in the industry, the options for exposure to emerging markets through ETFs are now numerous. Below, we highlight some of the alternatives to the ultra-popular EEM and VWO, noting some distinguishing features of each [sign up for the free ETFdb newsletter]:
High Income / Low Beta
The most recent addition to the emerging markets ETF space is HILO, a product from EGShares that offers exposure to a basket of 30 stocks from a handful of different countries. HILO is designed to deliver higher yield and lower volatility than cap-weighted emerging markets index, giving investors looking for a relatively safe way to access this asset class a potentially intriguing option.
The index underlying HILO is dividend yield-weighted, a methodology that varies slightly from dividend-weighted ETFs such as DEM.
ETFs have also become popular tools for focusing exposure on dividend paying companies, and there are multiple products that target emerging markets stocks with meaningful distribution yields:
- WisdomTree Emerging Markets Equity Income Fund (DEM): This ETF tracks a fundamentally weighted index that measures the performance of the highest dividend yielding stocks selected from the WisdomTree Emerging Markets Dividend Index. The product spreads its assets over a wide variety of companies ranging from micro to giant cap, giving DEM a healthy level of diversity. Currently, this ETF is paying out an SEC yield of 4.69% [see also Emerging Market ETFs: Alternative Weighting Edition].
- SPDR S&P Emerging Markets Dividend ETF (EDIV): This fund also tracks dividend paying companies in emerging markets but has a few key differences from DEM. Where DEM overweights financials, EDIV has a much better spread across all market sectors, which may give it a better diversity than DEM. EDIV focuses its assets on Brazil, Taiwan, and South Africa. EDIV has a current dividend payout of about 1.7%.
Another trend in the ETF industry has been the increase in popularity of alternative weighting methodologies; while cap weighting may still be dominant, a number of other options have gained traction in recent years thanks to concerns about potential inefficiencies. Beyond the dividend-weighted DEM profiled above, there are other options for accessing emerging markets without utilizing a cap-weighted approach:
- FTSE RAFI Emerging Markets Portfolio (PXH): This ETF employs the RAFI strategy, which computes the weight for components using four fundamental factors: book value, income, sales, and dividends–as opposed to a firm’s market cap. The fund favors giant and large cap companies like China Mobile and Gazprom, who take home two of the highest weightings in the ETF. PXH features a healthy exposure with over 300 holdings, and may be a great fit for investors seeking to stray from the normal weighting style that the exchange traded world features [see also Diamonds In The Rough: Ten Of Our Favorite ETFs With AUM Under $25 Million].
- MSCI Emerging Markets Equal Weight (EWEM): This Rydex product features some of the best diversity in the ETF world, as it tracks the stocks of nearly 600 emerging market companies that each receive the same weighting upon rebalancing. Equal weighting has become popular in recent years, as this approach helps to avoid a top-heavy portfolio (thereby reducing company-specific risk) and maintains a heavier tilt towards small and mid cap stocks. Investors should note that the top holding of this product is a WisdomTree India ETF (EPI), accounting for over 9% of the ETF’s assets, and is the only India exposure in the ETF. This is likely due to the fact that Indian stock exchanges are relatively illiquid, and this ETF may help alleviate some of those concerns. But because EWEM is not perfectly replicating its index, it will likely cause some tracking error that investors should be aware of before buying. As for the equal weight method, it seems to have outperformed its market-cap weighted counter parts in recent years, as evidenced by RSP outdoing ETF superstar SPY [see RSP Just Keeps Plugging Along].
Going Beyond Large Caps
|*Data as of 7/31/2011|
Like most “first generation” international equity ETFs, EEM and VWO are dominated by large cap stocks as these are the safest and most liquid stocks available. But there may be some drawbacks to this strategy; the majority of large cap emerging market ETFs have a tilt towards energy and financials sectors, skewing exposure away from strategically important sectors such as health care and consumers. Another issue with large cap companies is that they are typically multinational firms, meaning that their main business may not even come from the country from which they are domiciled. Small cap funds may offer a better “pure play” on these emerging economies as their individual holdings often have close ties to their respective economies.
- SPDR S&P Emerging Markets Small Cap ETF (EWX): This small cap product features over 700 holdings with no single security making up more than 1% of the ETF. From a sector standpoint, EWX favors technology (20%), though numerous other segments are given decent representation. Investors should note that Taiwan accounts for around 31% of this fund, meaning that the events and trends in this country will likely dictate the performance of EWX [see also Does South Korea Belong In Your Emerging Markets ETF?].
- Emerging Market SmallCap Fund (DGS): DGS is a small cap fund that also aims to invest in companies with strong dividend yields, giving it a different exposure and risk/return profile than EWX. This ETF features over 550 holdings with a healthy sector spread to reach into every corner of the emerging market world. DGS has a current SEC yield of 6.57% making it a strong candidate for those looking for steady income streams.
- IQ Emerging Markets Mid Cap ETF (EMER): EMER invests in emerging markets equities as well but instead focuses on mid cap companies, potentially giving this product more stability and less risk than a small cap fund. This relatively young product gives investors a new way to play emerging markets as mid caps still have strong growth potential, but less risk than small cap companies.
Value / Growth
Tilts towards value companies (low pricing multiples, high dividend yields) and growth companies (higher multiples, greater earnings growth potential) have been popular among investors for decades. A pair of ETFs from Global X allows investors to bifurcate the emerging market into these two streams as well:
- Russell Emerging Markets Growth ETF (EMGX): EMGX tracks an index which is designed to measure equity market performance of the largest growth companies in the global emerging markets, as defined by Russell. This fund features companies like Reliance industries and China Construction Bank, which are exhibiting high growth characteristics in today’s environment.
- Russell Emerging Markets Value ETF (EMVX): This ETF employs a similar strategy to EMGX, but instead focuses on value companies; those who may no longer be growing rapidly but likely paying out strong yields and are relatively stable companies. Top holdings in this product include names like Gazprom, China Mobile, and PetroChina.
While there aren’t any actively-managed emerging markets ETFs (at least not yet), there are a couple products linked to indexes that use quant-based methodologies in an attempt to generate alpha. While quant-based ETFs are typically more expensive, those fees may be more than justified if they succeed at generating alpha relative to cap-weighted funds. Below, we outline two quant-based emerging market funds for those wishing to stray from passive indexing:
- DWA Emerging Market Technical Leaders Portfolio (PIE): This ETF tracks an index which includes approximately 100 companies that possess powerful relative strength characteristics and are domiciled in emerging market countries. Of its 100+ holdings, big names like Kia Motors and Samsung Electronics appear in the top holdings of the fund while major country allocation of PIE focus on Malaysia and South Korea.
- Emerging Markets AlphaDEX Fund (FEM): FEM is another in a long line of AlphaDEX products which have proven themselves to have a strong track record in the markets which they have tracked. Generally, this fund picks its holdings by identifying stocks that may generate positive alpha based on the AlphaDEX strategy. Though this fund is too young to get a good read on its performance, investors may want to take a look at some of the other products utilizing this strategy to see if this methodology entices them [see also Seven Factors Every Investor Needs To Know About Emerging Market ETF Investing].
One common knock on EEM and VWO is the hefty weights afforded to economies such as Taiwan and South Korea that many consider to be developed. While index provider MSCI still classifies these markets in the “emerging” bucket, organizations such as the IMF have considered them to be developed for decades, and many metrics of these countries–such as literacy rates and life expectancy–are much closer to the U.S. than they are to Brazil or China.
In addition to the aforementioned HILO, EGShares offers what many consider to be a “pure play” emerging markets ETF:
- GEMS Composite ETF (AGEM): This ETF offers exposure that steers clear of these “quasi-developed” markets, focusing instead on the BRIC bloc and other smaller emerging and frontier economies like Chile and Malaysia. The fund features about 87 holdings.
All of the ETFs highlighted above offer exposure not only to equities of emerging market economies, but also to the currencies associated with these countries as well. For investors seeking exposure to emerging markets equities but looking to avoid the fluctuations caused by movement in the value of the dollar relative to the Indian rupee or Brazilian real, Deutsche Bank offers the MSCI Emerging Markets Currency Hedged Equity Fund (DBEM), a product that maintains the same holdings as VWO or EEM but strips out the currency exposure [see ETFs For Avoiding Currency Exposure].
Disclosure: Photo two courtesy of Warren Rohner. No positions at time of writing.