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Investors Miss Out Big On Smaller Emerging Markets

By
Dennis Hudachek
August 15, 2011
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Investors—and ETF providers—are missing a big opportunity in accessing smaller emerging market countries.

The Vanguard MSCI Emerging Markets ETF (NYSEArca: VWO) and the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) have been the darlings of emerging market investors for years. Together, the two funds have over $80 billion in assets under management.

Investor demand has been so strong that emerging markets funds now come in different sizes and styles. Besides broad-based funds, we now have large-cap, midcap, small-cap, growth, value and various emerging market sector ETFs.

Despite the variety, these funds share one thing in common: Almost all are market-cap selected, meaning investors end up heavily exposed to the same emerging markets giants—China, Brazil, Korea, Taiwan, South Africa, Russia, Mexico, India and Malaysia.

Together, those nine countries account for 88 percent of the exposure in a fund like EEM. That leaves just 12 percent of the portfolio to cover the remaining 11 countries, including fast-growing economies like Indonesia, Thailand and Chile. With all the niche ETFs being launched these days, it’s stunning that there’s no fund tracking a broad-based index of smaller emerging market countries. Where’s the love?

To be fair, some single-country smaller emerging markets ETFs exist, such as the Market Vectors Indonesia Fund (NYSEArca: IDX) and the iShares MSCI Chile Investable Market Fund (NYSEArca: ECH). But with IDX and ECH both having over $800 million in AUM, doesn’t that just prove the point?

Investors are eager to get their hands on the “next” emerging markets. Currently, they’re usually redirected to “frontier” markets like Vietnam, Qatar, Kuwait, Nigeria and the United Arab Emirates. Both Van Eck and Global X Funds currently have broad-based frontier market ETFs in registration with the Securities and Exchange Commission.

Smaller emerging markets are too developed to be classified as frontier; they’re just small. But they’re so small that they’re rendered irrelevant in broad-based emerging market portfolios. They’re the neglected middle child of risk-tolerant investors.

I think a smaller emerging markets ETF could be attractive. If you exclude the top nine countries from EEM and re-weight the remaining 11, you end up with a portfolio like this:

 

The “Smaller Emerging Markets”

Indonesia

21.63

Thailand

13.29

Chile

13.13

Poland

12.72

Turkey

11.91

Philippines

6.81

Hungary

4.78

Colombia

4.38

Peru

4.13

Czech Republic

3.40

Egypt

2.84

Total

99.01

Source: iShares website

 

Pretty nice, eh?

Doesn’t that look like a unique fund offering diversified exposure to high growth markets without pushing investors into “the frontier?”

Here’s hoping some issuer is paying attention.

 

ETF DAILY DATA

The consumer discretionary fund 'XLY' garnered a $1 billion-plus blast of creation on Tuesday, March 3. Still, a falling market offset net inflows and pulled total U.S.-listed ETF assets down to $2.092 trillion.

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