(Editor's Note: This article first appeared in ETF Report magazine.)
Over the past decade, leading state-owned enterprises from the financial, energy and mining sectors paved the way for the advance in broad emerging market indexes. In the coming decade, a different set of companies focused on consumers are expected to be in the vanguard of the next wave of growth.
According to research firm McKinsey & Company, annual consumption from emerging markets will hit $30 trillion by 2025, up from $12 trillion in 2010, and the global "consuming class" will swell to 4.2 billion in the coming decade.
ETF issuers have caught on to this tremendous growth opportunity. There are now three broad emerging market ETFs that specifically target consumers, and several other ETFs that indirectly target the rising theme. For investors looking to get granular, there are a handful of single-country consumer-focused ETFs.
The existing emerging-consumer ETFs differ in many ways. Some target only cyclicals, while others target cyclicals and non-cyclicals, as well as other sectors relevant to emerging consumers. Some include countries like South Korea and Taiwan, which drastically change the composition of the fund.
All of this leads to differences in performance, valuations, risks and volatility between the ETFs, so it pays to dig deeper to find the right portfolio based on your investment objectives.
Broad Emerging-Consumer ETFs
The EGShares Emerging Markets Consumer ETF (ECON | C-28) is the leading emerging market consumer ETF. The fund now boasts more than $1.1 billion in assets, and trades more than $6 million daily.
ECON is a highly concentrated, cap-weighted portfolio of 30 companies from the consumer cyclical and non-cyclical sectors. However, because it tracks an index from S&P Dow Jones Indices, ECON excludes exporting powerhouses South Korea and Taiwan, significantly deviating in country breakdown from MSCI-based emerging market benchmarks.
In comparison, the WisdomTree Emerging Markets Consumer Growth ETF (EMCG | D-43) casts a wider net than ECON, holding roughly 200 securities stretching beyond the two consumer sectors and into telecom, financials, information 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 value bias and a higher-than-average portfolio yield of 2.40%.
Finally, the cap-weighted iShares MSCI Emerging Markets Consumer Discretionary ETF (EMDI | D-43) focuses exclusively on consumer cyclical stocks. It holds roughly 90 securities from countries that MSCI classifies as emerging, meaning South Korean companies like Hyundai, Kia and LG Electronics dominate the fund's holdings.
The differences in structures lead to a spectrum of returns, but Figure 1 indicates the funds do follow roughly the same trajectory.
But there are still considerable differences. Over the past year in which emerging markets experienced turmoil, causing the broad iShares Core MSCI Emerging Markets ETF (IEMG | A-98) to return -2.66 percent, EMCG managed to eke out a gain of 1.70%.
Also pay close attention to valuations and volatility. ECON's 23.76 trailing 12-month earnings per share (Figure 2) gives it a huge growth bias over its peers. ECON also exhibited the highest daily volatility over the past year, though EMDI wasn't too far behind on that front.
Major differences in country breakdown can also impact each respective fund's performance (Figure 3). Each emerging economy is currently experiencing separate challenges politically, geopolitically and economically, so those factors are likely to weigh on each fund.
Developed Companies, Emerging Markets
In April 2014, emerging market specialist EGShares broke new ground with the launch of theEGShares Blue Chip ETF (BCHP | F-34). The fund holds only developed-market companies that derive a significant portion of their revenues from emerging markets.
The idea behind this theme is that many exporting companies from developed nations also stand to benefit from the rising emerging-consumer class.
BCHP isn't a consumer pure-play, but technology, cyclicals and non-cyclicals make up more than 50 percent of its weighting, combined. Many global consumer-focused companies like Yum Brands, Anheuser-Busch, Las Vegas Sands and Givaudan are among the fund's top holdings.
BCHP is a highly concentrated portfolio, holding only 30 securities. It's not conventional, but can be used as a complement for investors looking to add developed-market companies to their emerging-consumer-themed investment allocation.
Focusing On The Internet
New issuer EMQQ Index recently brought to market another ETF with a heavy footprint in the emerging market consumer space: the EMQQ Emerging Markets Internet & Ecommerce ETF (EMQQ).
EMQQ specifically targets Internet and ecommerce companies from emerging markets. A significant portion of emerging consumption is expected to take place over the Internet in the coming years, as advances in smartphone technology lead to a surge in the online retail market.
More importantly, EMQQ holds many U.S.-listed Internet and ecommerce consumer-focused companies excluded from broader MSCI- and FTSE-based emerging indexes.
Single-Country Consumer Funds
Investors looking to get more focused exposure have some options with single-country ETFs (Figure 4). Of course, local political and macroeconomic issues in each country will play a larger role in their returns compared with a diversified emerging-consumer ETF.
China's mission to reorient its economy from an export- to consumption-led model is well known. Luckily for ETF investors, there's an ETF that specifically targets Hong Kong- and U.S.-listed Chinese consumer companies.
The Global X China Consumer ETF (CHIQ | B-33) is the largest of these niche consumer ETFs, with more than $110 million in assets. For 65 basis points, CHIQ offers 40 securities from the cyclical and non-cyclical sectors.
The Global X Brazil Consumer ETF (BRAQ | F-42) offers roughly 40 securities from both consumer sectors in Brazil. BRAQ hasn't quite caught on with investors, and has only $8 million in assets, so we see risk of fund closure.
Finally, investors expecting reforms from newly elected India Prime Minister Narendra Modi to trickle down to the Indian consumer can focus on the EGShares India Consumer ETF (INCO | F-39). INCO is highly concentrated, holding only 30 companies from both consumer sectors. Of the three single-country consumer ETFs, INCO's been the best performer by a long shot over the past year.
Emerging markets hit a snag in 2014 for a number of reasons, including the end of quantitative easing in the U.S., a rising dollar, plunging commodity prices and rising local interest rates. Emerging-consumer ETFs certainly weren't immune to these negative forces.
But for long-term emerging market investors, the emerging consumer continues to look attractive. That said, it's imperative to understand the differences between the current offerings, particularly the broad-based approaches where the differences in exposure can be subtle.
For a pure play on the largest emerging-consumer companies, ECON fits that bill. Just keep in mind its higher valuations and volatility, which may be caused in part by its concentrated portfolio.
For a more diversified, less volatile play, EMCG may be fitting, as it casts a wider net across different sectors beyond just the traditional cyclical and noncyclical consumer sectors. Finally, EMDI provides pure cyclical exposure for those looking to tap directly into the discretionary spending habits of the emerging consumer.
There are many different ways to slice and dice this exciting growth theme. Once you figure out whether you want to go broad or focus on a single country, and which sectors you're interested in targeting, the right choice for your investment objective should be easily narrowed down.