Emerging market stocks have been red-hot over the past year amid a global rise in asset prices fueled by economic confidence.
As a result, exchange-traded funds that track these companies have become an increasingly bigger focus among investor portfolio decisions.
The most common starting place in the hunt for emerging market exposure are the largest and most well-known funds in this group. The Vanguard FTSE Emerging Market ETF (VWO), for instance, has over $68 billion dedicated to a diverse group of nearly 5,000 stocks spread throughout the globe. China, Taiwan, India, and Brazil dominate the top country rankings in this broad index for a miserly cost of just 0.14% annually to own.
VWO is the biggest, most liquid, and commonly benchmarked fund for emerging market (NYSEARCA:EEM)enthusiasts. Its only real competition being a low-cost offering from Blackrock in the iShares Core MSCI Emerging Markets ETF (IEMG), which shares a similar expense ratio and portfolio structure.
These funds are perfect for investors who want to participate in the emerging market theme with the highest degree of diversification. But what about those who want a more nuanced approach or that desire specific factor criteria in their international allocation? Screening methodologies that account for quality, momentum, value, volatility, dividends, liquidity or some combination of all six. These characteristics are becoming increasingly sought-after by discerning investors that are willing to pay a modest premium for differentiated exposure.
For instance, the Schwab Fundamental Emerging Markets Large Co. Index ETF (FNDE), tracks an index of emerging market stocks selected by fundamental measures of company size rather than market capitalization. The filtering criteria includes ranking companies according to sales, cash flow, dividends, and buy backs. The result is a more concentrated group of stocks, currently numbering 335, with an emphasis on larger size companies.
FNDE charges a reasonable expense ratio of 0.39% to implement this strategy for its shareholders and has proven to be an attractive alternative to conventional emerging market ETFs in recent years. The chart below demonstrates the outperformance of FNDE on a 3-year look back compared to VWO.
The success of this fund has not gone unnoticed by ETF investors either. FNDE attracted over $800 million in new capital over the course of 2017 and now ranks as the 10th largest emerging market ETF with $1.93 billion in total assets.
Another surging contender in this group is the Goldman Sachs ActiveBeta Emerging Markets Equity ETF (GEM). This enhanced index fund attempts to outperform traditional benchmarks by selecting companies based on metrics that include: attractive value, strong momentum, high quality, and low volatility. The resulting portfolio is filtered down to 400 emerging market stocks demonstrating these criteria.
GEM charges a net expense ratio of 0.50%, which is slightly more than three times greater than VWO or IEMG. Nevertheless, the multi-factor screens and potential for outperformance have managed to attract $1.77 billion in assets to this fund.
Many investors are now perceiving multi-factor ETFs as a better alternative to traditional active investment management. They receive quantitative-like security selection with the potential for outperformance at a fraction of the cost of high fee mutual funds. Furthermore, these ETFs are governed by strict rules-based investment criteria rather than the whims of a portfolio management team.
It’s also worth noting that single factor ETFs are popular as well. The iShares Edge MSCI Minimum Volatility Emerging Markets ETF (EEMV) is an example of this. EEMV owns just 268 emerging market stocks selected from a broad universe of eligible securities due to their historical penchant for lower volatility than their peers. Low volatility stocks are those that have shown smaller price swings, or narrower peaks and valleys, compared to the broader universe of companies.
This ETF has gradually swelled to over $4.7 billion in total assets with its appeal towards more conservative stock selection criteria. It’s very reasonable 0.25% expense ratio is also a strong selling point for cost-conscious investors.
The Bottom Line
Emerging market stocks have been in a momentum-driven uptrend for well over a year now and continue to show strong price patterns. Furthermore, their attractive fundamentals versus developed markets make them a potentially attractive regional opportunity. Global investors evaluating their current funds or considering adding to emerging market ETFs would be well served to analyze the competitive factor-based offerings in this class.
Note: At this time this article was written, the author owns shares of EEMV.