Guggenheim and Emerging Global, faced with distinct challenges with respective emerging market equities ETFs, in October will make changes to the indexes underlying each of those funds, a reflection of how developing market investments seem to be at a crossroads.
With its new index, the $218 million Guggenheim BRIC ETF (NYSEArca: EEB) will be adding global depositary receipts (GDRs), and with them, newfound access to Russia; while the $10.5 million EGShares Beyond BRICs ETF (NYSEArca: BBRC) will change to a FTSE index that integrates frontier-market holdings into the fund for the first time.
The index changes to EEB and BBRC come at a time when emerging markets asset prices have come under pressure for various reasons ranging from the slowdown in China, to middle-class unrest in places like Turkey and Brazil, to the prospect of normalizing borrowing rates in the U.S. With emerging markets out of favor and investors focusing on the U.S., it may be a perfect time for fund sponsors to make changes to funds they feel need tweaking.
“A lot is changing in the emerging markets,” said Dennis Hudachek, an ETF analyst at IndexUniverse, suggesting that perhaps now is as good a time as any to update strategies on funds that may be a bit out of step with the realities of modern emerging markets investing.
From BIC To BRIC
In the case of Guggenheim’s EEB, a first-to-market ETF that launched in September 2006, it never was a true BRIC fund to the extent that it lacked a substantial allocation to Russia, and the change this fall to the BNY Mellon BRIC Select DR Index addresses that shortcoming. It will abandon the BNY Mellon BRIC Select ADR Index at that time.
At the time of EEB’s launch, Russia was to some extent still living through the the difficult period of post-cowboy capitalism that flourished there in the 1990s in the immediate aftermath of the collapse of the Soviet Union.
Therefore, it was exceedingly difficult for U.S. investors to invest there, even using tools like GDRs, which are considered to be more liquid and that have holdings hewing more closely to U.S. standards in realms such as corporate governance, according to a Guggenheim official.
That’s no longer the case, as under President Vladimir Putin, the country has a newfound stability that has attracted the interest of U.S. investors, and the index change that allows for GDRs reflects that. The new index also still makes use of American depositary receipts (ADRs).
EEB will also, for the first time, be able to own Hong Kong-listed China H-Shares. The fund’s China exposure has featured GDRs exclusively since its inception. The fund is down 9.41 percent year-to-date through Aug. 27, accoring to IndexUniverse data.
But now, given that some H-share firms that aren’t part of a GDR are now perfectly fine from a liquidity standpoint, the fund will be able to pick up China exposure through such individual securities.
The increase to allocation in Russia will mean exposure to China and Brazil will fall in the new arrangement, and, from a sector-allocation perspective, the percentage of energy-related holdings will increase because of the heavy energy tilt in Russia’s economy.
Beyond Emerging Markets
The EGShares Beyond BRICs ETF, a fund that has had an alluring premise from the first, will add to that allure with its index change by focusing on frontier markets for the first time, as noted above.
At the time of its launch in August 2012, BBRC was pitched as a security designed to lead developing markets investing in a new direction. Surely, investors wouldn’t gravitate to funds like the Vanguard FTSE Emerging Markets ETFs (NYSEArca: VWO) or the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) forever.
Indeed, returns on funds like VWO and EEM are now correlated rather closely with developed market equities, undermining one of the main attractions of emerging markets investing.
Moreover, from a returns perspective, it’s not preposterous to worry that the best returns on funds like VWO that focus on bigger companies in the emerging markets may well be in the past.
But the two aims in developing-markets investing—low correlations and relatively high expected returns—are likely to be enhanced in the new BBRC. That’s because the fund’s new benchmark, the FTSE Beyond BRICs Index, will allow for up to a third of the fund’s allocation to be on so-called frontier markets. The fund will drop the Indxx Beyond BRICs Index at the time of the change.
The new index will also allow for up to 75 percent of holdings to be in more economically developed emerging market countries.
“This means this fund is going to have United Arab Emirates and Qatar as heavyweight frontier markets and then maybe Vietnam,” IU’s Dennis Hudachek said.
“I like this fund, but it’s really hard to compete against VWO and EEM, and having FTSE in there is a big step toward that rebranding. Investors will likely be a lot more willing to buy into a fund with a major index behind it,” he added. The fund is down 11.9 percent YTD through Aug. 27.
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