Softening An Emerging Market ETF Ride

December 13, 2018

Emerging market ETFs have had a tough year in 2018, but if you owned a low-vol EM ETF this year, the plunge you faced was far less steep. Just know that lower volatility wasn’t the only bet you were making.

Consider the year-to-date performance of the most popular emerging market ETF this year, the iShares Core MSCI Emerging Markets ETF (IEMG)—which has attracted more than $14 billion in new assets—and its low-vol counterpart, the iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV):

 

Chart courtesy of StockCharts.com

 

Volatility

EEMV did exactly what it’s designed to do in markets like we’ve seen this year—offer a smoother, less volatile ride, mitigating some downside risk. The fund is designed to move less than the market in either direction, up or down.

EEMV has annualized volatility of about 13%, compared with 19% for the broader strategy, BlackRock data show. Also, the beta of EEMV to the S&P 500 is 0.77 versus IEMG’s 1.05. A beta of less than 1 means a security is less volatile than the market. In other words, EEMV is as its label suggests: a low-volatility strategy.

But opting for a low-vol fund comes with other size and style bets you should understand as part of your due diligence.

Size & Sector

Using EEMV as an example, the first thing you will notice when comparing EEMV and IEMG’s portfolio is the sheer size difference. IEMG has almost 6 times as many securities in its portfolio—nearly 1,800 in all—versus EEMV’s 287 stocks. EEMV is a far more concentrated emerging market play.

More importantly, in another “size” metric that really impacts portfolio performance, EEMV tilts a lot to a smaller market capitalization than IEMG. The portfolio has a weighted average market cap of $38.8 billion, almost half of IEMG’s average. It is also underweight some of emerging markets’ largest names.

In the universe of emerging market equities, often some of the largest companies are financials, materials, oil and gas companies—higher-beta stocks you may not find in EEMV. Sector tilts also impact portfolio performance.   

“EEMV has more defensive exposures,” said Chris Dhanraj, head of iShares' Investment Strategy at BlackRock. “Our favorite sector for 2019—health care—represents about 5.9% in EEMV versus 2.9% in IEMG. EEMV is lower vol and lower size. It tends to look smaller-cap, and that has helped you in this case.”

“You get more of the domestic story with EEMV,” Dhanraj added.

 

EEMV vs. IEMG Portfolio Breakdown

Sources: ETF.com, FactSet data

 

Quality

EEMV looks for quality in its pursuit of a lower-volatility portfolio. That means that, relative to IEMG, the fund tilts toward defensive stocks, as noted, as well as regions seeing more sustainable and quality growth.

Specifically, EEMV focuses more on greater Asia—Taiwan, Korea, Thailand—and less on China compared to a total market approach. According to Dhanraj, that reflects BlackRock’s outlook for the region, saying that greater Asia is currently offering higher-quality plays, and should continue to do so in 2019.

Here’s a look at how EEMV and IEMG stack up against each other, and against the broader segment of emerging market ETFs: EEMV is higher quality, smaller size and much, much lower vol.  

 

Source: Style Analytics

 

Value & Growth

EEMV also differs from a total market approach such as IEMG when it comes to value and growth. EEMV goes for quality—not for the cheapest stocks, nor the most growth-y ones. And that’s interesting, because the fund doesn’t offer a lot of access to growth names, but neither it does it tilt toward value. 

The portfolio’s price/earnings ratio is 14.03, according to ETF.com data, notably higher than IEMG’s 11.6 P/E ratio.

“Some of the cheapest stuff in EM, like Turkey and Russia, have in some cases become value traps,” Dhanraj said. “We don’t want value exposures. We want quality in EEMV.”

Here’s how the two portfolios stack up in various measures of value and growth:

 

Source: Style Analytics

 

How To Use EEMV

It wasn’t that long ago that ETF investors only had access to broad-based market-cap-weighted emerging market ETFs such as EEM, IEMG and others, like the Vanguard FTSE Emerging Markets ETF (VWO). These funds have grown into massive portfolios boasting billions of dollars in total assets as core building blocks in portfolios everywhere.

EEMV—and other targeted exposure such as currency-hedged plays—aren’t necessarily replacements for broader ETFs, but often used as complements, according to BlackRock.

Consider that in 2018, when many EM ETFs faced redemptions, both IEMG and EEMV have attracted assets. IEMG took in a net of $14 billion in fresh net assets, while EEMV has gathered almost $400 million in net creations, or 8% total asset growth.

Still, if you are considering replacing core emerging market exposure for a low-volatility approach such as EEMV as volatility picks up, understand what other bets you are making. What you are getting and what you are giving up will directly translate into what your total returns look like.

Contact Cinthia Murphy at [email protected]

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