‘David’ Emerging Market ETF Vs ‘Goliaths’

Every once in a while, an ETF hits all the right notes at the right time. The WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (XSOE) fits that category.

Broadly, the fund competes in a space that has been hugely popular with investors: emerging market equity ETFs.

In 2017, investors poured more than $160 billion into international equity ETFs—almost as much as they did into U.S. equity funds—and emerging market funds were big in-takers, with ETFs like the iShares Core MSCI Emerging Markets ETF (IEMG) and the Vanguard FTSE Emerging Markets ETF (VWO) among the year’s most popular strategies.

So far in 2018, that demand for emerging market exposure has gone unabated, benefiting large and small ETFs in the segment alike. Asset leaders like IEMG, VWO and the iShares MSCI Emerging Markets ETF (EEM) have seen more than $9.5 billion in combined net creations year-to-date; the smaller XSOE has attracted almost $80 million in net assets under management (AUM), bringing it to $92.6 million in total AUM.

Performance Angle

XSOE’s growing resonance with investors among some well-established competition has a lot to do with how the portfolio is performing. In the past 12 months, this small ETF has outperformed its main competitors such as IEMG and VWO by as much as 10 percentage points, as the chart below shows.

This outperformance has been a trademark of XSOE since it came to market in December 2014, beating the likes of IEMG, VWO, EEM and even the Schwab Emerging Markets Equity ETF (SCHE) to date.

Due to the fund’s exclusion of state-owned emerging market companies—defined as any company in which the government owns at least a 20% stake—the portfolio tilts differently than other vanilla approaches. XSOE offers smaller concentrations in financials and energy sectors, and larger ones in consumer-focused and tech names.

For example, XSOE allocates 33% to info tech names, and 21% to consumer discretionary and staples combined. IEMG, on the other hand, has 26% in info tech and 16% in consumer names. Financials, meanwhile, represent 17% in XSOE versus 22% in IEMG. These aren’t huge differences in sector allocations—as the charts below show—but they drive different returns over time.

According to WisdomTree, state-owned enterprises totaled about 300 emerging market companies last year, with market value totaling about $2 trillion combined, or almost 35% of the market cap of broad emerging market indices. That’s a big slice of the market that’s not found in XSOE.

China Angle

A lot of that market value, WisdomTree says, is concentrated in China’s financials sector.

China has been making headlines recently as it goes head to head with the U.S. in a brewing trade war that began with the U.S. tacking tariffs on imported steel, and this week saw China respond with new tariffs on 128 U.S. products.

XSOE’s exposure to China avoids large state-owned mainland names that have been hit hard by the trade battle. Consider the year-to-date performance of the A-share-focused Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR) versus the H-share-focused iShares China Large-Cap ETF (FXI) year-to-date:

Charts courtesy of StockCharts.com

XSOE’s focus away from state-owned companies means its 30% allocation to Chinese equities also looks different from what other emerging market ETFs offer. When MSCI added some 200-plus China A-shares to its MSCI Emerging Markets Index last year, many of which are state-owned companies, WisdomTree added only 50 names to its mix.

ESG Angle

Finally, XSOE also offers something for investors looking to own exposure to emerging markets from an ESG lens, specifically those concerned with governance.

State-owned companies answer to government and private shareholders, and often they find that these two groups have differing priorities. Supporting government objectives isn’t always the same thing as providing private shareholder value.

In XSOE, those types of governance concerns and government influence on decision-making don’t matter because the company excludes state-owned names. As WisdomTree puts it, XSOE owns only names that are “freer to compete globally.”

The MSCI ESG Fund Quality Score for XSOE found on ETF.com’s fund report is 4.5 out of 10, placing XSOE in the 46th percentile within its peer group.

“If non-state-owned enterprises continue to outperform state-owned enterprises in the future, this strategy is designed to tap into that differential in returns as a potential source of alpha for emerging market investors,” WisdomTree’s Luciano Siracusano said in a recent blog.

Contact Cinthia Murphy at [email protected]