Smaller Emerging Markets ETF Hot New Trend

The firm joins a new era of emerging market investing with the launch of a new fund.

Today iShares launched a promising new emerging market ETF based on the “beyond BRICs” theme that’s gained momentum in 2014. I’m personally a fan of this new ETF and expect it to do well in the coming years.

Three years ago, I blogged on the need for a “smaller emerging markets” ETF. The new iShares MSCI Emerging Markets Horizon ETF (EMHZ) certainly looks like the answer to that blog.

EMHZ is a “smaller country” version of the $36 billion iShares MSCI Emerging Markets ETF (EEM | B-98) that holds the bottom 25 percent of EEM’s market cap by country. This means emerging markets (EMs) like Mexico, Malaysia, Indonesia and Thailand dominate the fund’s weighting, as opposed to the BRICS, Taiwan and South Korea.

Not The First Beyond BRICs ETF, But Different

To be clear, EMHZ is far from being the first beyond-BRICs ETF to launch. There are currently three other funds that target this up-and-coming theme.

The $309 million EGShares Beyond BRICs ETF (BBRC | D-36) was the first to launch back in August 2012. BBRC reaches beyond emerging markets to also include the frontier markets, as classified by FTSE.

The $151 million Global X Next Emerging & Frontier ETF (EMFM | C-37), launched in November 2013, is a similar “smaller emerging/larger frontier” markets ETF.

Meanwhile, the smallest of the bunch, the $3 million SPDR MSCI EM Beyond BRIC ETF (EMBB | F-59), is simply a version of EEM that excludes the four BRIC nations, but leaves South Korea and Taiwan in the mix.

EMHZ separates itself from BBRC and EMFM by limiting itself to strictly emerging markets, as defined by MSCI, but it goes beyond State Street’s EMBB by also stripping out South Korea, Taiwan and South Africa.

 

2014—A Breakthrough Year

2014 has been a breakthrough year for these innovative emerging market ETFs, as well as frontier markets.

Investors may have begun questioning the “emerging” status of countries like the BRICs, South Korea and Taiwan, compared with a decade ago. It’s only a natural progression that emerging markets eventually grow into developed markets.

Other investors may be front-running the lengthy process of country upgrades according to the strict methodologies of major index providers.

Or, investors may just be searching for new markets with less “co-movement” to broad U.S. and emerging market indexes. For example, BBRC has an R-squared of only 0.66 to the MSCI Emerging Markets IMI Index, suggesting low “goodness of fit.”

Source: ETF.com

EMFM’s R-squared is even lower—0.64—to this same MSCI benchmark, again suggesting little co-movement here.

Source: ETF.com

 

As expected, EMBB’s R-squared is higher—0.85—as it excludes frontier markets altogether.

Source: ETF.com

Emerging ETF Innovation On The Rise

Both BBRC and EMFM have been some of the fastest-growing ETFs of 2014, based on flows as a percentage of assets.

BBRC has pulled in $257 million in 2014 through the end of the third quarter, growing at a blistering 1,147 percent clip. EMFM has pulled in $142 million, growing roughly 973 percent.

Meanwhile, as of the end of the third quarter, EEM had net outflows of $603 million while VWO’s had net outflows of $190 million.

Looking at the bigger picture, the dominance of EEM and VWO as a total percentage of broad emerging market ETF assets has decreased from roughly 90 percent to about 80 percent since the beginning of 2011.

 

Source: ETF.com

To be clear, in no way am I calling for the demise of EEM and VWO. In fact, I expect them to remain the dominant emerging market ETFs in the coming decade.

But I wouldn’t be surprised if EEM and VWO didn’t regain that 90 percent of total assets level, as investors increasingly become selective in their emerging market exposure.

There’s now more than $108 billion in U.S.-listed, broad emerging market ETFs. I wouldn’t be surprised to see other emerging market ETFs continue to gain a larger percentage of that large pie.

 

Beyond ‘Beyond BRICs’ ETFs

Besides the “beyond BRICs” theme, we’ve seen additional innovation on the emerging market front this past year.

EGShares recently launched the first “revenue-based” emerging markets ETF. The EGShares Blue Chip ETF (BCHP) holds “developed market” companies that gain a significant portion of their revenues from emerging markets.

I expect more of these types of revenue-weighted emerging market ETFs in the coming years, including some based on MSCI’s “Economic Exposure” indexes.

Finally, there are a few recent filings in the pipeline that have caught my attention.

We’ll soon have a broad emerging market ETF from KraneShares that’ll track a version of the FTSE Emerging Markets Index, but with a major twist. The new fund will include full coverage of China’s A-share market, plus U.S.-listed China N-shares to its broad emerging market exposure.

The new KraneShares FTSE Emerging Markets Plus ETF offers investors a glimpse of what the Vanguard FTSE Emerging Markets ETF (VWO | C-89) might look like years from now when China eventually brings down barriers to foreign investment in its domestic market.

Finally, WisdomTree’s filing for its Emerging Markets ex-State-Owned Enterprises Fund looks interesting.

This new fund will likely tilt away from the usual financial and energy sectors dominated by SOEs and offer investors something new: an emerging market fund that tilts toward sectors dominated by entrepreneurial companies.

As quantitative easing draws to a close in the U.S. and certain emerging markets veer off from the rest of the pack in terms of size and demographic trends, I only expect more innovation on the emerging market ETF front.

These newer emerging market ETFs tied to specific themes, or those that challenge conventional definitions of “emerging markets,” could continue to gain momentum. Stay tuned.

 

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