Emerging Market ETFs Require Due Diligence

July 13, 2017

Todd Rosenbluth is director of ETF and mutual fund research at CFRA.

Investors who included an emerging market equity fund in their well-diversified asset allocation strategies have been rewarded, as many of the popular strategies have outpaced the S&P 500 index. However, despite similar names, what’s inside these funds can be very different.

The average emerging market mutual fund rose 18.1% in the first half, ahead of the 8.2% average gain for U.S. equity funds. However, the passively managed iShares Core MSCI Emerging Markets ETF (IEMG) was up an even more impressive 18.7%. Inclusive of the extra trading days thus far in July, IEMG was up 18.0%, ahead of the 17.7% for the emerging market mutual fund average.

Even among passively managed funds, there are differences in performance, often due to the underlying holdings.

For example, consider the Vanguard FTSE Emerging Markets Fund (VWO) and its mutual fund share class Vanguard Emerging Markets Stock Index Fund (VEMAX). Based on name alone, one might think the two Vanguard products offer the same investment opportunity as IEMG. In fact, all three boast an expense ratio of just 0.14%. But VWO was up “just” 14.4% and VEMAX 14.6% in 2017.

                       

Not All Emerging Market Funds Perform the Same

Source: CFRA’s MarketScope Advisor, July 7, 2017

 

A simple matter of tracking error? With passive funds, investors will often look to how well the product tracks its underlying index. But according to data on ETF.com, IEMG has a median tracking difference of 11 basis points, only slightly lower than the 17 basis points for VWO.

Tracking error does not seem to be the reason for the performance difference. Rather, CFRA strongly believes the 360-basis-point performance differential is the result of what’s inside these popular funds.

 

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