3 Most Overlooked Emerging Market ETFs

Emerging markets have gone through a volatile ride since Ben Bernanke’s “taper” speech in May 2013. The MSCI Emerging Markets Index is still down around 3.6 percent since that day.

 

More recently, we’re seeing a wide divergence in the returns between different markets. Within the BRICs—which have matured significantly over the past decade—Chinese growth is slowing, while politics and/or geopolitics weigh on Russia and Brazil. India is the lone shining star. 

 

 

Source: StockCharts.com

 

There may be reasons to invest in the BRICs individually, but the big question remains, do the BRICs still make sense grouped together as a single asset class?

 

Many investors are now questioning what emerging markets will look like in the coming decade. Beyond the BRICs question, what sectors are poised to lead the next wave of growth besides state-owned financial, energy and mining companies?

 

Fortunately for ETF investors, there’s now a plethora of other options besides the $31 billion iShares MSCI Emerging Markets ETF (EEM | B-97) and the $46 billion Vanguard FTSE Emerging Markets ETF (VWO | C-83). Combined, these two ETFs account for about 80 percent of total assets within broad emerging market equity ETFs.

 

But with all the newer choices, it can be difficult to know what exists, let alone what to pick.

 

In such an environment, investors are likely to overlook some strategies. So, with the possibility of such oversights in mind, here are three overlooked ones that I think deserve more attention from investors looking beyond EEM and VWO for the coming decade.

 

Note: These ETFs were selected based on their strategies, not on costs and liquidity. Being relatively new funds, asset levels and trading volumes may be thin, so be mindful of overall trading costs.

 

iShares MSCI Emerging Markets Horizon ETF (EMHZ)

The newest emerging market ETF from iShares is literally a “smaller market” version of its blockbuster ETF, EEM.

 

It may be a stretch to call EMHZ overlooked, because it’s still so new—it launched in October 2014—but compared with EEM’s $31 billion, it’s shocking that EMHZ is still sitting on its seed capital of around $2.25 million.

 

EMHZ captures the bottom 25 percent of EEM’s country market cap, meaning it strips out the BRICs, South Korea, Taiwan and South Africa. The resulting portfolio gives you hefty weightings in countries like Mexico, Malaysia, Indonesia, Thailand, Turkey and Poland.

 

I view this “beyond BRICs” ETF—again, EMHZ—as our Alpha Think Tank emerging market portfolio. That’s because several of the strategists we interview for the publication have favorable views on the most heavily weighted countries in EMHZ.

 

For example, Mexico is favored by geopolitical strategists Ian Bremmer and George Friedman, as well as Medley Global’s Fitzsimmons. Indonesia is favored by Bremmer, Fitzsimmons and Tom Dorsey, the latter of whom also likes Malaysia. Meanwhile, Cumberland’s David Kotok says to never take your eyes off of emerging Asia, which accounts for more than 40 percent of EMHZ.

 

EMHZ is unconventional, but for those questioning the BRICs as a single asset class, or simply want more weighting to the countries that get overshadowed in their current strategy, EMHZ may be worth a look.

 

Note: The segment benchmark is the MSCI Emerging Markets IMI Index.

Source: ETF.com

WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (XSOE)

XSOE is also brand new, launched in December 2014. The fund seeded with $10 million, which suggests some institutional interest, as most new ETFs seed with only $2.5 million.

 

As the fund’s name suggests, XSOE is play on emerging markets without the dominating hand of state-owned enterprises (SOEs) in the mix.

 

Investors have long questioned the motives of SOEs—whether they truly act in the best interests of shareholders—because politics and state interests can play a role in their business decisions.

 

Interestingly, from a sector perspective, many SOEs that dominate the holdings of EEM and VWO are financial and energy companies, predominantly from China, Russia and Brazil.

 

XSOE eliminates China’s “Big 4” state-owned banks, three of which sit in EEM’s top 10 holdings. The fund also eliminates big energy names like Gazprom, Petrobras, CNOOC and PetroChina.

 

Instead, XSOE tilts more toward consumer-focused sectors—technology, cyclicals and non-cyclicals—poised to grow in the coming decade on the backs of the rising emerging consumer class.

 

Note: The segment benchmark is the MSCI Emerging Markets IMI Index.

Source: ETF.com

 

WisdomTree Emerging Markets Consumer Growth ETF (EMCG | D-44)

It’s no secret that the emerging consumer class is poised for big growth in the coming decade. According to a research report from McKinsey & Company, annual consumption from emerging markets will hit $30 trillion by 2025, up from $12 trillion in 2010.

 

Thus far, the $1.1 billion EGShares Emerging Markets Consumer ETF (ECON | C-32) has taken the lion’s share of assets in this space. ECON is a solid choice for investors looking for a concentrated portfolio of the 30 largest consumer cyclical and non-cyclical emerging market companies.

 

But for investors looking for a more broadly diversified approach, EMCG casts a wider net than ECON, holding roughly 200 securities stretching beyond the two consumer sectors and into telecom, financials, technology and industrials.

 

EMCG differs significantly from ECON by following an “enhanced beta” approach, combining growth and valuation factors to select its holdings, then weighting them by annual income. This approach gives EMCG a deep value bias and a portfolio yield of 2.45 percent, roughly equivalent to EEM.

 

EMCG looks to me like it’s one of those great funds that simply got lost in the shuffle. Surprisingly, it only has $20 million in assets, but I hope that number grows in the coming years. The fund captures an alluring theme expected to grow significantly in the coming decade.

 

EMCG vs. EEM: Total Returns Since Fund Inception On Sept. 27, 2013

Source: StockCharts.com

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At the time this article was written, the author held a long position in EMHZ. Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.