Sometimes, the line between developed and emerging markets is
razor thin. This has especially been the case for two of Asia’s
largest economies; Taiwan and South Korea.
These two nations represent some of the most robust economies in
the region both from a total level and a per capita reading, but
are often classified as ‘emerging’ by some of the major index
firms. In particular, the indexing giant MSCI still classifies them
as developing countries although other benchmark providers, such as
Dow Jones, have moved these nations into the developed market
club.
Some had hoped that MSCI would finally move up the two nations
into developed market status at its annual review of country
classifications, but both remained firmly in the emerging market
camp according to the index provider. This forces these two
countries to stay in the emerging market realm for another year,
hoping that the company will come around on these two nations in
2013.
This annual rejection continues to surprise some in the industry
as South Korea and Taiwan both have large markets that are much
more diverse than many of their small peers that are already
classified as industrialized nations (see Three Overlooked Emerging
Market ETFs).
In fact, both of the nations have, according to the IMF, a
higher GDP per capita (PPP) than the EU average, while both have
exceptionally high rates of economic freedom and competitiveness
that put many other ‘industrialized’ members to shame.
Why It Matters For ETF Investors
While this problem may not seem very important to most investors
on the surface, it actually has a huge implication for emerging
market ETF investors. Thanks to MSCI’s refusal to put either of the
countries in the developed market indexes, they have grown to make
up an outsized percentage of some of America’s most popular
emerging market ETFs.
This includes two of the top ETFs on the market today both of
which track the MSCI Emerging Markets Index. These two funds, the
Vanguard MSCI Emerging Markets ETF (VWO) and the
iShares MSCI Emerging Markets Index Fund (EEM)
account for nearly $85 billion in AUM as well as the lion share of
assets in the developing market ETF world (see Seven Biggest
International Equity ETFs).
However, both of the funds, since they follow the MSCI
methodology, have close to one-fourth of their assets in the
combination of Taiwan and South Korea. This suggests that the
products may not offer the ‘truest’ emerging market exposure and
instead have a great deal of assets in companies from countries
that are arguably developed and not emerging.
Ways To Avoid
Luckily for investors, there are a number of ways to avoid this
issue thanks to the proliferation of emerging market ETFs. No more
does the space consist of just MSCI based products giving investors
a choice among over 50 ETFs that have assets exclusively in
emerging nations (see more in the Zacks ETF
Center).
Below, we highlight three of our favorite emerging market ETFs
which offer no exposure to either Taiwan or South Korea. While both
of these markets could make for fine investments, we don’t believe
that they should be treated as emerging by any means, suggesting
that for better emerging market ETF exposure, the following ETFs
should be considered instead:
EGShares Low Volatility Emerging Markets Dividend ETF
(HILO)
This product tracks the Indxx Emerging Market High Income Low
Beta Index which is a dividend yield weighted benchmark that looks
to provide investors with a higher payout and less volatility than
the aforementioned MSCI Emerging Market Index. Currently the
product has 30 securities in its basket, pays out a dividend of
about 6.4%, but sees fees of around 85 basis points per annum.
In terms of country exposure, Thailand takes the top spot at
16.9% of assets but it is closely trailed by Chinese and Brazilian
securities as well. Beyond these nations, South Africa, Hungary,
and Malaysia round out the top six countries represented (see
Frontier Market ETF Investing 101).
Given the focus on high dividends and low volatility, investors
shouldn’t be surprised to note that telecom (33%) and utilities
(17%) constitute the majority of the assets. Beyond these two
segments, cyclical consumer stocks, along with industrials and
consumer staples, complete the top five leaving just under 25% for
financials, energy, tech, and basic materials.
iShares MSCI BRIC Index Fund (BKF)
For a BRIC-focused alternative, investors have a couple of
choices. We like BKF for its relative balance among the four
nations of Brazil, Russia, India, and China, especially when
compared to some of its peers. The product also holds an impressive
number of securities at over 300, while charging investors a
reasonable 67 basis points a year in fees.
BKF puts 40% of its assets in China, 30% in Brazil, and then
roughly the rest in equal amounts between India and Russia. The
product’s yield isn’t too impressive at just over 1.1% in 30 Day
SEC Yield terms, but it does a great job of spreading assets around
putting just 27.5% of assets in the top ten holdings (see Top Three
BRIC ETFs).
From a sector perspective, financials and energy account for
roughly 50% of assets, while basic materials is the only other
segment to make up more than 10% of the total. Large caps also
dominate the exposure profile, although it should be noted that
there is a definite tilt towards growth firms as well.
EG Shares GEMS Composite ETF (AGEM)
For a broad play on the emerging market space without the
influence of South Korea or Taiwan, AGEM presents a compelling
choice by tracking the Dow Jones Emerging Markets Sector Titans
Composite 100 Index. This benchmark, as the name suggests, holds
100 stocks in its basket and provides broad exposure across a
variety of market segments in numerous nations around the
globe.
The ETF charges investors 75 basis points in fees for its
services but hasn’t really caught on with investors so far. The
average volume is still below 10,000 shares a day suggesting that
bid ask spreads could be relatively wide in this fund (read Go
Local With Emerging Market Bond ETFs).
Still, it represents a solid pick for long term investors as it
has a well diversified portfolio that doesn’t put more than 5% in
any one security. Sector exposure, however, is tilted towards
energy and financials, although telecom and consumer staples both
account for double digit allocations as well.
For countries, China takes the top spot at just over 27% of the
total, followed by a 16% allocation to Russia and a 14% holding in
Brazilian firms. The next three markets are South Africa, India,
and Mexico, suggesting that the product also has a nice mix among
the various emerging regions of the world.
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Follow @Eric Dutram on Twitter
Author is long VWO.
EGS GEMS COMPST (AGEM): ETF Research Reports
ISHARS-MSCI BRC (BKF): ETF Research Reports
ISHARS-EMG MKT (EEM): ETF Research Reports
EGS-LO VT EM DV (HILO): ETF Research Reports
VIPERS-M EM MKT (VWO): ETF Research Reports
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