EEM: Beyond The Bloodbath

February 04, 2011

The bottom seems to have fallen out from under EEM. But it may not matter.

Ever since the Vanguard MSCI Emerging Markets ETF (NYSEArca: VWO) displaced the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM) as the world’s biggest emerging markets fund last month, things seem to have gone from bad to worse for iShares.

EEM lost almost $7 billion in assets last month, and the bloodbath extended right into February’s first trading session, as investors pulled $777 million out of the fund on Feb. 1. I’ve got to hand it to you, Matt: You pretty much called it when you said this would happen. But I doubt it matters.

To start, your blog, “How To Save The EEM Franchise,” laid out some useful ideas for investors about the future of emerging market investing that are already near and dear to the folks at iShares.

When I reached out to talk to iShares, they emphasized their family of single-country ETFs, many of which are focused on the emerging markets. In sum, they said they had $87 billion in assets under management focused on the emerging markets. (I wonder if the sum isn’t now closer to $80 billion, given EEM’s bleeding since it was toppled by VWO on Jan. 18.)

Maybe it’s just corporate spin, but I think there is something to the idea that the “EEM vs. VWO” horse race we’ve been all excited about might be yesterday’s news in terms of how investors can access emerging markets in more and more specific ways.

Whether iShares can successfully fend off competitors, including upstarts such as Global X and Emerging Global, really remains to be seen.

Like so much in this world, it comes down to following the money trail. And, the overall picture for iShares is positive. They have a whole lineup of single-country funds that, on the whole, are pulling in assets. Take its iShares MSCI Malaysia Index Fund (NYSEArca: EWM): It expanded by a third in 2010, and this year has crossed the $1 billion threshold. Not too shabby. But it’s not all good news.

For example, the $2.28 billion that EEM hauled in last year was just about wiped out by the $2 billion that came out of the iShares FTSE/Xinhua China 25 Index Fund (NYSEArca: FXI). FXI, a six-year-old fund, still has more than $7 billion in assets. By comparison, the SPDR S&P China ETF (NYSEArca: GXC) you talked up in your year-end blog added almost $90 million in assets last year and is now a $717 million fund.

On the other hand, the iShares MSCI Brazil Index Fund (NYSEArca: EWZ) raked in more than $500 million in new money last year, and it’s already added another $800 million this year, making it an almost $12.5 billion fund. It’s easy to forget EWZ has been around for 10 years, a long time in the ETF industry.



Pinprick Accuracy

Whatever ends up happening to the long shadow iShares casts over the ETF industry, the point is that a more granular approach to getting investment exposure to the emerging markets has been brewing for a while and is now gathering momentum.

That has made it easier for newer funds, like the SPDR S&P Emerging Markets Small Cap ETF (NYSEArca: EWX) or the WisdomTree Emerging Markets SmallCap Dividend Fund (NYSEArca: DGS) to get traction. EWX has gathered more than $1.15 billion since it came on the market in May 2008, while DGS has attracted almost $1 billion since it launched in October 2007.

Even Rob Arnott, perhaps the leading figure of the fundamental indexation movement, is getting a piece of the action via the PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca: PXH). The ETF almost doubled its assets last year, and is now a $526.8 million fund. It launched in September 2007.

Investors have clearly shown they’re willing to shed their home-country bias, and I expect this battle for market share to take place on the frontier—literally and figuratively.

First, while the $19.34 billion Vanguard’s VWO gathered last year far exceeded all other U.S. ETFs—and not just EEM—I wonder again whether that’s not yesterday’s emerging markets story. Could Vanguard, long a champion of owning the whole market and dispensing with the guesswork as to which parts will outperform, be a bit vulnerable as the emerging space gets sliced and diced into smaller pockets?

In all fairness, it does seem to be out in front with the Vanguard Global ex-U.S. Real Estate ETF (NasdaqGM: VNQI), an ETF it brought to market in November. VNQI holds REITs and also includes emerging-market real estate operating companies, or REOCs, something the folks out in Valley Forge, Pa. describe as an industry-first. The ETF now has $86.5 million.

Vanguard aside, there’s no better example of appetite in the U.S. for innovative emerging market investments than what happened last summer when the WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) and the Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) came to market.

Both ETFs went gangbusters—especially ELD, which now has $630 million in assets, compared with about $250 million for EMLC. The biggest difference between the two is that ELD has an active screening process that steers clear of Hungary, perhaps the most indebted Eastern European country right now.

Investors are clearly tuned in to what matters. They’re over fretting about holding debt denominated in currencies other than the dollar, and they’re parsing credit risks. At this rate, I wouldn’t be surprised to see Global X’s two new offerings that split the emerging markets into growth and value take off as well.

I also wouldn’t be surprised to see someone run with your idea, Matt, and design a fund around an index that combines emerging and frontier markets to decrease correlations to developed markets. Whether iShares ends up being that company is another story for another day.


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