Emerging Markets ETFs: Value Or Trap?

Recent market action and asset flows paint a cloudy picture.

Sometimes asset flows data offer a glimpse into investor sentiment about certain pockets of the market. This year, however, it’s been hard to tell what ETF investors are thinking about emerging markets.

Consider net creations and redemptions in the five largest total market emerging market equity ETFs year-to-date:

The largest of these funds, the Vanguard FTSE Emerging Markets ETF (VWO) and the competing iShares MSCI Emerging Markets ETF (EEM) have seen combined net outflows of $6.5 billion.

On the flip side, the iShares Core MSCI Emerging Markets ETF (IEMG) has taken in a massive $10.6 billion. The Schwab Emerging Markets Equity ETF (SCHE) and low-volatility EM play, the iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV), are also net gainers.

Lest you think this divergence in demand is all about chasing performance, think again. Year-to-date, these funds have delivered nearly identical results, with the exception of low-volatility EEMV, which is faring better than the rest.

Mixed Sentiment

Perhaps the mixed sentiment is linked to a mixed picture for the region. One of the main appeals of an emerging market equity allocation has long been the potential for outsized growth relative to developed markets. Many say that potential remains a viable long-term theme centered on consumer and demographic trends.

But in the shorter term, investors may find themselves on a white-knuckle ride. And to many, stomaching the downturn may prove too much to bear.

There’s no question that emerging markets have struggled this year. A Bloomberg article recently coined the biggest trouble spots right now as a catchy acronym: “BATS”—that stands for Brazil, Argentina, Turkey and South Africa.

Consider the performance of these countries’ equity markets using single-country market-cap-weighted ETFs as proxies:

• The iShares MSCI Brazil ETF (EWZ) is down nearly 22% year-to-date.
• The Global X MSCI Argentina ETF (ARGT) is down 28.5% year-to-date.
• The iShares MSCI Turkey ETF (TUR) is down 52% year-to-date.
• The iShares MSCI South Africa ETF (EZA) is down 27.5% year-to-date.

Local Issues Grow

These four nations share a mix of high inflation, seriously weakened currencies, rising political turmoil amid vocal local protests, economic contraction and hefty debt burdens.

They are not alone—these are just the headliners this year. Beyond them, there’s also Indonesia, with a currency now sitting at 20-year lows. There’s China and its ongoing trade spat with the U.S., and so on.

“Local market issues surrounding Turkey, Argentina, South Africa, and Brazil have reminded investors of tangible political risks that are producing conditions less hospitable to foreign investments,” said Ben Lavine, CIO of 3D Asset Management.

“Heavily indebted countries will likely find themselves shut out of the borrowing market just at the moment when they need to roll over this debt,” Lavine added, noting that some $1.2 trillion of U.S. dollar-denominated emerging market debt is expected to mature through 2020—debt that’s more difficult to pay with weaker currencies.

Time To Buy?

Net creations in IEMG and other emerging market ETFs suggest there’s buying taking place. IEMG is one of the most popular ETFs year-to-date. Gary Stringer, head of Stringer Asset Management, sees the current environment where prices are beaten up as a buying opportunity thanks to a long-term fundamental story.

“These headline issues have weighed on the segment, but they have nothing to do with the long-term economic and consumer spending growth prospects of these countries,” Stringer said in a recent blog. “On the contrary, the shift from low to middle income and from poverty to middle class is a tangible, long-term theme.”

Kristina Hooper, chief global market strategist at Invesco, also anticipates “bargain hunting” at these levels, though not without risk.

“In the shorter term, I believe the situation is likely to worsen, especially given expectations that the Fed is very likely to raise rates at the end of the month, which could place more pressure on emerging markets,” she said in a blog. “However, I expect bargain hunters to be out sniffing around soon given the potential for serious mispricings as the entire region may be painted with the same brush.”

Market At A Glance

ETF investors buying into this valuation play have more than 200 emerging market ETFs to choose from—some broad, some vanilla, some smart beta, some single-country, some fixed income.

Among the lowest-cost funds are some of the largest total market ETFs, such as SCHE, IEMG and VWO. SCHE costs 0.13% in expense ratio, the other two cost 0.14%. That’s $13, or $14 per $10,000 invested, respectively.

Together, these three ETFs command a massive $113.5 billion in combined assets. They are also pretty large portfolios, SCHE with just about 1,000 holdings; IEMG with 1,800 stocks; and VWO with a whopping 3,800-plus securities.

Korea Question

One notable distinction between them beyond portfolio size is South Korea. VWO and SCHE don’t invest in South Korea, tilting more heavily into China and India relative to IEMG’s portfolio. IEMG, meanwhile, sees South Korea as an emerging market, and holds it as the second-largest country allocation, at about 14% of the portfolio.

The cheapest EM total market ETF is the SPDR Portfolio Emerging Markets ETF (SPEM), with a price tag of only 0.11%. Launched in 2007, it has $1.4 billion in assets, and it too considers South Korea a developed market. The ETF is down 10% this year.

Among the top 20 total market EM ETFs there are also some smart-beta strategies. One of the best-performing this year, as noted, is EEMV.

What’s Working Best

EEMV adopts a volatility-weighting methodology designed to offer investors a low-vol mix of emerging market stocks. EEMV invests in South Korea, but the portfolio ultimately tilts toward midcap and growth names, according to FactSet data.

Year-to-date, the low-vol approach has fared better than market-cap ETFs, dropping only 3.8% versus its competitors’ double-digit declines. EEMV has $4.6 billion in assets and costs 0.25% in expense ratio.

There’s also the multifactor Goldman Sachs ActiveBeta Emerging Markets Equity ETF (GEM), which picks stocks based on value, momentum, quality and low volatility. The portfolio, which allocates most heavily to China and South Korea, has gathered $1.7 billion in assets, and costs 0.45%.

Charts courtesy of StockCharts.com

For a complete list of competing funds in this pocket of international equities, please check out our emerging market ETFs channel.

Contact Cinthia Murphy at [email protected]