How 4 Advisors Use Emerging Market ETFs

[This article appears in our October 2020 issue of ETF Report.]

Samuel Deane
Financial Planner
Deane Financial Partners

Emerging markets make up about 10-20% of a globally diversified portfolio allocation for Samuel Deane’s clients, who generally are younger and can take on more risk. His clients’ portfolios lean heavily on equities, anywhere from 80-100%.

He includes emerging markets because they have the potential to create higher returns. “My investment philosophy regarding emerging market ETFs is that they can come in all shapes and sizes,” Deane said. “But not every fund, for lack of a better phrase, is worth your time and money.”

He has two starting criteria when it comes to an emerging market ETF: low fees, and ones that are large and liquid enough to buy and sell with no complications.

“Many low-cost index funds are competitive on price and have billions in assets that drive a higher average trading volume,” Deane explained. “Those are the sort of things that I look into when deciding which ETF to implement in our strategies.”

One of the emerging market ETFs he’s using is the Vanguard FTSE Emerging Market ETF (VWO), an index-based ETF that excludes South Korea. Deane says he likes that it offers broad-based exposure and invests in large and small cap stocks, including China A-shares.

However, Deane says he’s considering looking at other funds, too, because he wants to lessen his exposure to China. Mainland China, Hong Kong and Taiwan comprise more than 50% of the fund. Deane notes that he’s looking at the Freedom 100 Emerging Market ETF (FRDM), a principles-selected, market-cap-weighted index fund that has no exposure to mainland China or Hong Kong, although says he has not researched it deeply yet.

“It’s something I’ve thought about recently, although I haven’t made any changes,” Deane added.

Nate Fischer
Chief Investment Strategist
Strategic Wealth Partners

Nate Fischer uses emerging market ETFs for smaller accounts where buying individual securities would be costlier.

“If you’re looking for cheap, easy beta [in emerging markets], ETFs are the best way to play it,” Fischer said.

His firm uses both equity and fixed income products, many from the iShares suite, including the iShares Core MSCI EAFE ETF (IEFA) for broad equity exposure and the iShares Core International Aggregate Bond ETF (IAGG) on the fixed income side.

If Fischer has a macro theme or believes the U.S. dollar will outperform a certain country’s currency and wants a tactical allocation, he may consider a currency-hedged equity strategy using the offerings from WisdomTree.

When investing in emerging market bonds, Fischer says advisors need to think about the impact of the U.S. dollar so it doesn’t act as a head wind: “You’ve got to be cautious about that when you’re buying bonds.”

If the U.S. dollar is strong, he may employ the iShares Interest Rate Hedged Emerging Markets Bond ETF (EMBH), or if If the U.S. dollar is weaker, the unhedged iShares JP Morgan USD Emerging Markets Bond ETF (EMB).

In a portfolio breakdown, on the equity side, 20-30% of the portfolio is allocated to international holdings, with 40% of that to emerging markets. On the fixed income side, Fischer treats bonds similarly to high yield holdings—anywhere from 0-15%.

“They do offer pretty decent yields, but you’re assuming a lot of risks versus a 10-year Treasury,” he noted.

Timothy Hooker
Co-founder
Dynamic Wealth Solutions

Timothy Hooker uses emerging markets as his clients’ only exposure to international markets at this time, with holdings representing 10-15% of a client’s equity allocation.

His clients generally are aggressive investors driven by performance. It’s one of the reasons Hooker doesn’t use broad-based emerging market ETFs, and instead uses niche and sector funds instead.

“Our clients say they want emerging market exposure because they see this as an opportunity for the long term,” he said. “Our investors are aggressive. They like to see performance and capital appreciation, and we believe that the ETF is a great way to capture that return.”

There are two emerging market funds Hooker uses: the KraneShares CSI China Internet ETF (KWEB) and the First Trust Chindia ETF (FNI).

Hooker uses KWEB to target the growth in the rise of the Chinese middle class and their increased discretionary income. The expense ratio for KWEB is 76 basis points, which he admits is expensive, but says that the return justifies the higher fee.

“It’s not as diverse as some of the Vanguard and SPDR funds,” he explained. “These are high-conviction funds:  61% of KWEB’s holdings are in in the top 10.”
For clients who want less China exposure or want more exposure to India, Hooker says FNI fits the bill. He sees the ETF as a good way to diversify away from China and still post strong returns.

Even though these are concentrated ETFs, Hooker uses them as core emerging market positions. And these two funds get his clients interested in emerging market investing.

“When we started our firm six years ago, we used funds like SPEM [SPDR Portfolio Emerging Markets ETF] and DEM.” Hooker noted, “But we couldn’t get clients excited about them as much as we can with KWEB and FNI.”

Rob Williams
Principal, Managing Director
Sage Advisory Services

On the equity side of a client’s portfolio, Rob Williams allocates between 60% domestic stock and 40% international, with about 10% in emerging market ETFs, generally. He prefers broad-based ETFs, but will occasionally tilt to add regional exposure.

Williams says right now there are a few good reasons to have emerging market holdings, including monetary policy, a weaker dollar and attractive valuations. Looking toward the end of the year, he’s more cautious, because of the coming election and tensions between the U.S. and China.

The iShares Core MSCI Emerging Markets ETF (IEMG) is Williams’ pick for core emerging market exposure, and he currently has a tilt toward Asia, using the iShares MSCI Emerging Markets Asia ETF (EEMA) to express that view.

For investors with an income focus, he’s used the DEM, and for clients with an environmental, social and governance mandate, the iShares ESG MSCI EM ETF (ESGE) fits the bill.

On the fixed income side, Williams will either choose a dollar-based ETF or one that’s based on the local currency, depending on his view. He cautions that advisors need to be aware of the exchange rate impact on the fixed income side.

William’s core fixed income emerging market ETFs are either the iShares JP Morgan USD Emerging Markets Bond ETF (EMB) or the Invesco Emerging Markets Sovereign Debt ETF (PCY). PCY is similar to EMB, he explains, but the nuance with PCY is that it’s all sovereign debt: “EMB has a little corporate debt mixed in there, so if we want a broader base, but want to include some credit, we’ll use that one.”

Those two are dollar-denominated, so there’s no currency bet. If Williams has a view on the dollar weakening, or wants exposure to local currency, his pick is the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC).