Broad emerging market equity ETFs have been hot this year. The four biggest ETFs in this segment—the iShares Core MSCI Emerging Markets ETF (IEMG), iShares MSCI Emerging Markets ETF (EEM), Vanguard FTSE Emerging Markets ETF (VWO) and Schwab Emerging Markets Equity ETF (SCHE)—have collectively gathered some $11.5 billion in net inflows already in 2018.
But when it comes to performance, it’s the much smaller PowerShares S&P Emerging Markets Low Volatility Portfolio (EELV) that’s delivering gains. EELV is basically a lower risk take on emerging market equities, tracking a volatility-weighted index of emerging markets companies—the least volatile names get the biggest weighting in the portfolio.
EELV hasn’t really outperformed a fund like IEMG since 2013, but it’s doing just that this year, rallying 3.4% while broad EM funds struggle to break even.
Chart courtesy of StockCharts.com
EELV vs. IEMG: Country & Sector Tilts
While there’s no clear catalyst for EELV’s outsized performance relative to the segment, country and sector allocations could be helping drive the disparity in gains. According to FactSet data, country exposure explains 1.75% of EELV’s 3% outperformance year-to-date, while sector allocations explain another 1.08%.
“EELV has more exposure to countries and industries that would benefit, or at least be less harmed by a U.S.-China trade war,” Scott Burley, Factset ETF analyst, said.
Among the portfolio’s biggest country bets are allocations to Thailand, Malaysia and Taiwan, all of which have done well this year thanks in part to strong currency moves against the U.S. dollar. On the other hand, EELV offers less exposure to India than most EM ETFs, and India has not been a strong performer.
On sectors, Burley noted that EELV “avoided recent weakness in the tech and consumer discretionary sectors, while its tilt toward financials paid off.”
“EELV’s low-vol mandate gives it a tilt toward large-cap/value stocks, but IEMG’s large-cap/value stocks haven’t outperformed by much,” he added.
Flows Finding EELV Performance
As the fund has risen, so has the investor demand for it. So far in 2018, EELV has seen net creations of more than $430 million, most of which came in recent days. Asset manager Gradient Investments is behind a big chunk of the fund’s inflows this month.
According to portfolio manager Jeremy Bryan, the firm’s Gradient Tactical Rotation (GTR) portfolio moved out of the PowerShares S&P Emerging Markets Momentum Portfolio (EEMO) completely, and into EELV due to a change in price momentum. GTR is a rules-based strategy that’s built based on an algorithm that goes where it sees the best price opportunity.
According to Bryan, that opportunity today is in low-vol emerging market stocks, which are displaying stronger momentum as volatility picks up globally.
“Fundamentally, as we’ve seen volatility pick up overall, the low-vol environment in EM is outperforming. And we expect that to continue,” he explained. “From an algorithm perspective, there’s better momentum in low vol right now, and we’ll stay there until price momentum changes.”
GTR had been invested in emerging market momentum since May 2017, and it wasn’t until this month when it moved out of that position—some $420 million worth—and into EELV as the algorithm shifted.
“We feel people are still under-owned on emerging markets given years of underperformance,” Bryan said. “Combine that with the U.S. now in a tightening phase—later in the cycle than other international markets—we think emerging markets could continue to be a place to be for the next two to three years.”
For now, he says, the place in emerging markets to be is in low vol. GTR revisits its allocation once a month.
EELV has $707 million in total assets, and costs 0.29% in expense ratio. Other ETFs accessing emerging market equities through a volatility lens include the $4.7 billion iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV), which is a minimum-volatility portfolio. EEMV is up 1% year-to-date, and has seen net inflows of about $50 million year-to-date.
Contact Cinthia Murphy at [email protected]