Beyond EEM: Alternative Emerging Market ETF Options
The most popular emerging markets ETF is the iShares MSCI Emerging Markets Index Fund (EEM), which has nearly $40 billion in assets and has seen cash inflows of more than $3.5 billion so far this year. But investors looking for exposure to emerging markets through ETFs should be aware that EEM, while liquid and efficient, has some material drawbacks. This ETF has an expense ratio more than 2.5 times comparable funds tracking identical benchmarks (such as VWO), and only holds about half of the individual stocks that make up the underlying index.
So before you put your money (or your clients’ money) into the biggest fund available, consider several of the potentially appealing emerging markets ETFs available:
Dow Jones Emerging Markets Composite Titans Index Fund (EEG)
This ETF from Emerging Global Advisors offers a “pure play” on emerging markets equities, using guidelines determined by the International Monetary Fund (IMF) to identify countries that fit the definition of an emerging market. These qualifications include:
- GDP per capital between $2,000 and $20,000 (economies with per capita GDP below $2,000 are considered “frontier” while those above $20,000 are generally considered “developed”)
- Absence of a mature middle class society
- Commodities-based economies
The end result of utilizing these standards to determine eligibility is that Israel, South Korea, and Taiwan, which the IMF elevated to “developed” status more than a decade ago, are not included in EEG. It may surprise some investors to learn that EEM has about 24% of its holdings in South Korea and Taiwan, two countries that the IMF considers to be developed.
EEG avoids these “quasi-emerging” markets and instead allocates a greater percentage of its holdings to the BRIC markets of Brazil, China, India, and Russia. As of September 30, these four countries made up more than 75% of the index underlying EEG. Beyond the BRIC, EEG has exposure to South Africa, Mexico, Malaysia, Indonesia, and Chile as well.
SPDR S&P Emerging Markets Small Cap ETF (EWX)
Most emerging markets ETFs, including EEM, VWO, and EEG, invest primarily in large-cap companies such as Gazprom, Petrobras, and China Mobile. As its name suggests, EWX focuses on small-cap companies in emerging markets, investing in companies that have a market capitalization less than $2 billion. While the biggest allocations in EWX, Turk Hava Yollari (a Turkish airline company) and Charoen Pok Foods (a Thai food company) aren’t exactly household names, this fund delivered stellar returns since its inception in May 2008.
Investors looking to invest in small cap U.S. stocks have a number of options to choose from, including value, growth, and blend funds. But for investors looking to invest beyond the U.S., ETFs focusing exclusively on small cap stocks are hard to come by. Besides EWX, options include:
- Claymore/AlphaShares China Small Cap Index ETF (HAO)
- iShares MSCI EAFE Small Cap Index Fund (SCZ)
- WisdomTree International SmallCap Fund (DLS)
- PowerShares FTSE RAFI Developed Markets ex-U.S. Small Cap Portfolio (PDN)
Investments in emerging market economies come with certain risks, potentially including significant political risks. Small cap companies within emerging markets are therefore one of the more risky asset classes available to U.S. investors, combining the risk factors of both emerging markets and the smallest of publicly-traded companies. To compensate for this risk, EWX offers some potentially exciting return characteristics. The ETF has a forward price-to-earnings ratio of under 14 and a 3-5 year EPS growth rate of more than 30% (as of 11/23/2009), providing an attractive opportunity for investors looking to increase emerging markets exposure.
WisdomTree Emerging Markets Equity Income Fund (DEM)
This ETF is designed to measure the performance of the highest dividend-yielding emerging markets stocks, selecting the highest 30% of companies included in the WisdomTree Emerging Markets Dividend Index. With more than 225 individual holdings across every sector and almost 20 countries, DEM may present an attractive fundamentally-weighted option for gaining emerging markets exposure. However, this ETF allocates about 40% of its holdings to the “quasi-developed” economies of Taiwan, Korea, and Israel, making it less of a pure-play emerging markets fund.