Hidden Gem ETFs

December 01, 2017

WisdomTree Emerging Markets Ex-State-Owned Enterprises Fund

Emerging markets have been the consensus trade of 2017. Investors entered the year significantly underweight emerging markets in their portfolios, and those that added exposure early were rewarded, with major emerging market indexes rising 35% or more in the first 10 months of the year.

But at Inside ETFs, we’re convinced most emerging market investors own the wrong funds. they pay too much for the wrong kind of stocks, often ending up in quasi-government-owned companies that do more for the politburo than they do for your portfolio.

XSOE caught our eye for this exact reason. By excluding state-owned enterprises, it offers exposure to the kind of emerging market companies that investors actually want … you know, the ones trying to change the world and deliver significant returns to shareholders. XSOE is the emerging market fund you always wanted to own.

Matt Hougan, CEO, Inside ETFs: Why did you launch XSOE?
Luciano Siracusano, Chief Investment Strategist, WisdomTree: WisdomTree wanted to create a way for investors to get broad exposure to emerging markets without owning state-owned enterprises. XSOE is a broad-based emerging markets fund that screens out companies when governments own at least 20% of their stock. We like to think of it as a way to get beta exposure to the private sector companies of emerging markets.

What’s wrong with state-owned enterprises?
It’s hard for managers to serve two masters at once. If you’re trying to maximize shareholder value and serve public interests at the same time, sometimes you can run into conflict. We like the idea of creating an index that is focused on the companies, sectors and countries that are most primed to compete globally.

Coincidentally, when you do that, you exclude some of the Chinese banks, Russian energy companies, and Brazilian energy and telecom companies that many people are worried about in emerging markets portfolios. Instead, you get exposure to sectors and stocks that are globally competitive and, frankly, those that are more focused on the emerging markets consumer.

You would assume this kind of portfolio would be heavily overweight tech and underweight banks and energy. Is that true?
With XSOE, we were explicitly trying to create a fund that gives you a country and sector exposure that’s very similar to what you find in a cap-weighted index, so we control for those under- and overweights.

To do that, we start by looking at the universe on a float-adjusted, cap-weighted basis. Then, we remove state-owned enterprises, which typically represent about 25% of the weight of a typical benchmark. Once that’s done, we go back into those countries that had stocks removed and we replace the holdings we took out until we end up with a country weight that’s very similar to the original, cap-weighted benchmark.

Once that’s done, we look at the sector weights across the globe and try to be within 3% of the cap-weighted sector weight at our annual rebalance.

Our goal is to not make a big bet on the country or sector exposure; our big bet is on private companies outperforming government-controlled entities.

What does XSOE replace in an investor’s portfolio?
We think it can replace an investor’s core emerging markets exposure. We think it’s a way to get beta exposure to the true private sector of emerging markets.

Isn’t XSOE riskier than a traditional emerging market ETF (which would own state-owned enterprises)?
The data doesn’t support that. For the three years that the index has been live, its beta has actually been slightly lower than the MSCI Emerging Markets Index, and its volatility has been slightly lower as well.*

Is the fund liquid enough to trade?
XSOE is a newer fund, and right now it only has about $30 million in assets. But the fund is primarily made up of large-cap companies that are very liquid, so when you look at the implied liquidity of the underlying basket, we think there is the ability to trade about 1.6 million shares a day. That’s obviously much higher than the average volume, so we feel there is plenty of liquidity in the underlying stocks.

Many smaller ETFs have high expense ratios; yours is only 32 basis points (0.32%). How did you set the pricing of the fund?
The fund is cheaper than a fund like the iShares MSCI Emerging Markets ETF (EEM), which charges 0.70%, but more expensive than the cheapest emerging markets ETF. We priced XSOE competitively in the environment we are in today.

How has performance been?
The fund has been around for nearly three years, and it’s been able to generate about 200 basis points of annualized excess return over the MSCI Emerging Markets Index and about 300 basis points of annualized return over the FTSE Emerging Markets Index.*

One notable thing about the fund is it includes A-shares. Why did you make the decision to include domestically listed Chinese stocks?
The index industry is moving gradually towards the adoption of A-shares in all emerging markets portfolios. FTSE is already there, and MSCI has announced its intention to add A-shares as well.

We think that’s where the industry is going, and we want to be a forward- looking emerging markets ETF. We’ll evaluate each year what the right weight of A-shares in the portfolio should be. Right now, it’s 5%, and we think that’s right. It’s another part of the story that people find appealing.

If you had to sum up XSOE in one sentence, what would you say?
It’s the emerging markets exposure you always wanted, with companies that are actually trying to make a profit.


*Source:
WisdomTree data as of 11/1/2017; www.wisdomtree.com/etfs/equity/ xsoe

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