The Great Emerging Markets Rebound

August 29, 2014

After 2013’s sell-off, it’s almost a no-brainer that emerging markets are looking attractive.

Last year, no one wanted emerging market exposure, as the U.S. stock market climbed sharply higher while developing economies underperformed. But in recent months, there’s been a sort of reversal of fortunes in equities, with emerging market ETFs standing out in different ways.

The driving factor fueling this renewed demand for emerging market exposure seems to be attractive valuations. After being beaten down in 2013, many of these developing economies are now offering good bang for the buck, particularly relative to U.S. equities, which are at record high levels. Investing is all about expected returns, and they’re still elevated after last year’s sell-off.

“In 2013, equity markets in Europe, Japan and the United States delivered strongly. Emerging markets, on the other hand, were disappointing,” Christopher Gannatti, WisdomTree’s associate director of research, said in a recent blog.

“However, it is at precisely these times—after being disappointed—when emerging market equities probably warrant a closer look,” he said. “We remain excited about the valuations represented within emerging markets today compared to other global markets.”

In the emerging market ETF space, there are plenty of plain-vanilla as well as alternative-methodology ETFs to choose from, and their performances are as unique as the exposure they offer.

The Big Plain-Vanilla 3: EEM, VWO, IEMG

Value-focused investors started in earnest to pile into emerging market ETFs in April. They were concerned that U.S. economic growth was shaky, and that geopolitical unrest in Russia and the Middle East would derail the tentative recovery in developed markets such as the U.S. and Europe.

The iShares MSCI Emerging Markets ETF (EEM | B-98)—one of the largest ETFs in the segment, with $44 billion in assets—has been the most popular of its lot, gathering a net of $8.65 billion in net new assets since April 1, 2014. Also, its price has rallied more than 10.6 percent in the period.

That's impressive if you consider that coming into 2014, EEM’s price had slid about 6 percent in the previous year, and investors yanked more than $5.31 billion from the fund. That disappointing performance stood in stark contrast to the SPDR S&P 500 (SPY | A-99)’s 32.2 percent rally in 2013.

EEM is the second-biggest emerging market ETF after the Vanguard FTSE Emerging Markets ETF (VWO | C-90) in terms of assets, and the two represent the bulk of investor assets in this segment. But EEM is anchored around a MSCI benchmark that many institutional investors favor. It’s also one of the most comprehensive, liquid and efficient portfolios of emerging market equities today.

But the $44 billion EEM is also one of the most expensive in the segment, with a 67 basis point expense ratio, or $67 for every $10,000 invested—something the fund tries to compensate investors for through an aggressive securities-lending program.

That reality is part of the reason VWO leads in terms of assets under management, with $50 billion, despite its exclusion of South Korea—a market MSCI still considers to be emerging—largely because the Korean won isn’t as convertible as MSCI thinks befits a developed country.

To that point, South Korea represents roughly 15 percent of competing EEM. That’s not a negligible allocation, and its presence or absence affects performance.

 

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