Emerging Markets' Wild Ride

It’s been a wild ride for emerging markets (EM) so far this year.

After starting 2019 with a bang, the world’s largest EM fund, the $63.8 billion Vanguard FTSE Emerging Markets ETF (VWO), was suddenly caught reeling.

VWO’s stellar year-to-date gain of 15.7% in April turned into a much more modest 4.6% gain in May, depressed by persistent worries about the U.S.-China trade war and slowing global growth.

Then, just as fast as the ETF tumbled, VWO resurged in June, rising to a 12.6% year-to-date gain, putting it in range of this year’s high as the U.S. and China called a temporary trade truce and the Fed hinted at interest rate cuts in July.

The rival iShares Core MSCI Emerging Markets ETF (IEMG), with $58.9 billion in assets and significant exposure to Korea, followed a similar path this year—a hot start, followed by a retrenchment and then a strong rally (see Figure 1).

Despite sporting sizable gains this year, emerging markets certainly aren’t immune from the worries that continue to weigh on global markets. The U.S.-China trade war remains front and center in investors’ minds.

Add on top of that fresh concerns about the U.S.-Europe trade relationship or even the Japan-South Korea trade relationship, and you have a recipe for fear, uncertainty and doubt, which gives investors pause.

China ETFs Surprise
Still, despite the plethora of concerns out there, this year’s strong returns suggest investors are trying to take it all in stride. The double-digit return for EM stocks this year was a sweet surprise.

Even more surprising are the returns for China stocks in particular. Despite being ground zero for the most consequential trade war in decades, China stocks are actually doing quite well this year.

In fact, eight of the top 10 best-performing EM ETFs are China funds. That includes the Global X MSCI China Consumer Staples ETF (CHIS), up 37.7%; the CSOP FTSE China A50 ETF (AFTY), up 32.9%; and the KraneShares CICC China Leaders 100 Index ETF (KFYP), up 29.8% (see Figure 2).

The fact that China ETFs are outperforming to such a strong degree in the face of such negative news flow is pretty impressive.

Analysts point to relatively cheap valuations following last year’s drop in China stocks and potential government buying as factors that could be propping up China ETFs in 2019.

Russia More Investor Friendly?
The only two non-China ETFs to land in the top EM ETF list are the Franklin FTSE Russia ETF (FLRU) and the iShares MSCI Russia ETF (ERUS), each up around 30%.

Russian ETFs have been doing well this year after several high-profile companies significantly hiked their dividends this year, bowing to pressure from Russia’s Finance Ministry to give more money back to shareholders.

Energy giant Gazprom more than doubled its dividend unexpectedly in May, fueling a more than 40% increase in its share price. Gazprom is the largest holding for most Russia ETFs, and its recent investor-friendly move has no doubt buoyed sentiment in the broader Russian stock market.

India’s Divergence
While China dominates the best-performing EM ETF list, the other side of the ledger features a more eclectic group of funds.

At the top of this worst performers list is the VanEck Vectors India Small-Cap Index ETF (SCIF), down 10.5% year to date. SCIF is one of several India-related ETFs that have fared poorly this year despite the recent reelection of business-friendly Prime Minister Narendra Modi (see Figure 3).

Counterintuitively, SCIF and the others on the list—including the Columbia India Consumer ETF (INCO) and the iShares MSCI India Small Cap ETF (SMIN)—have done badly, even as the largest ETF in the space, the iShares MSCI India ETF (INDA), has rallied nearly 7% this year.

The difference comes down to exposure. INDA is weighted heavily toward large cap Indian stocks, and financial, technology and energy stocks in particular. The India ETFs that have lagged this year focus on small caps and consumer stocks—areas that have underperformed.

Outside of India ETFs, other poor-performing EM ETFs include the iShares MSCI Turkey ETF (TUR), the iShares MSCI Chile ETF (ECH) and the iShares MSCI Qatar ETF (QAT), with returns close to zero.