Is it time to invest in emerging markets? Perhaps you’ve already invested in bitcoin and blockchain technology and are using a cryptocurrency index to track their changes. But that just wasn’t enough. Now you are looking to further diversify your portfolio. If so, then this is an area that you might want to consider. After all, there is a great big world out there, with lots of untapped potentials. Many now have some optimism that the worst of the Coronavirus pandemic might be over. This has resulted in the injection of government stimulus packages, and talks of restarting the economy now might be the time to start wading in. A good way to start is with emerging market ETF’s but this still doesn’t narrow it down. That’s why we put together a list of what we believe are the 5 best emerging markets ETFs.
Note: This article is for educational purposes only and is not intended to be financial advice. Please use it along with other resources to learn about ETFs.
Emerging Markets Defined
What is an emerging market? An emerging market is an economy that is between the stages of developing and developed. It is defined as an economy having a low-to-mid-range per capita income. The four largest countries in this category are Brazil, Russia, India, and China (BRIC). It is at this stage that these economies will see their most rapid growth, as well as their greatest volatility. But if proper caution is exercised, the rewards of investing in an emerging market can greatly outweigh the risks.
For example, let’s look at the last decade. From 2000 to 2010, emerging markets as tracked by the MSCI Emerging Markets Index saw an average annual return of nearly 16%. This was compared to the S&P 500’s merger return of -0.95%. The following decade, however, from 2011-2019 saw the MSCI Emerging Markets index return just 2%. Keep in mind, this is compared to the roughly 13% of the S&P 500. These figures demonstrate the potential reward of investing in emerging markets as well as their volatile nature.
Several factors have weighed on the mediocre performance of emerging markets. In this last decade, this has included the strong U.S. dollar, various political disruptions in several emerging market economies, and declining commodity prices. This has hit commodity-exporting countries hard.
A Market With Growth Potential
But with U.S. stock market valuations at an all-time high, emerging markets may be one asset class that still has room to grow. However, just don’t expect the same performance as the 2000-2010 decade, which was a market aberration caused by, among other things, the commodities supercycle, and China entering the global trading system.
What are some reasons for investing in emerging markets? Well, consider this. Of the nearly 200 countries in the world, about 80% are classified as ‘emerging’. Together, they account for close to 60% of the global GDP (Gross Domestic Product). This number will only continue to increase in the future, as the rate of growth in these countries is expected to double those of developed countries.
Considering The Trends
There are strong secular trends that support growth in these economies. Emerging markets (EM) are home to about 85% of the world’s population. They also hold roughly 90% of the world’s population under 30. This sector of the population is becoming more well-educated and has increased access to disruptive technology and innovation. This means that advancements in these economies will occur faster than they have in developing economies in the past. Additionally, this has also led to the rise of a rapidly growing middle class who want access to goods and services. Taken together, they present what one analyst calls, “the biggest growth opportunity in the history of capitalism.”
Other reasons to invest in emerging markets are diversification, exposure to different stages of the economic cycle, and attractive valuations relative to developed markets. Emerging markets currently trade at a price to earnings ratio of around 12%, compared to U.S. equities which currently sit at 17%. U.S. companies are pushing the ceiling in terms of growth and expansion. At the same time companies in countries, like China and India, are just getting started in selling their goods and services to a booming middle class.
Consider An ETF
The fact is, investing in emerging markets just got easier with the rising popularity of emerging markets ETFs. These ETFs provide an alternative to individual stock picking. This is because ETF’s reduce risk while allowing you to add a country or combination of countries to your portfolio. They are also an alternative to mutual funds because they offer more liquidity since they trade like stocks. And they have much lower expense ratios, with some as low as 0.1%. Keeping these stats in mind, you will also be able to navigate the uncertain waters of the fear and greed index.
There are currently 79 emerging market ETFs. About half are traditional, market capitalization-weighted indexes. The rest employ a more strategic approach such as specific allocations to certain sectors, or perhaps a focus on high dividend stocks. Also, we should take into account which countries are included in the ETF. This can have a bearing on actual returns. However, comparisons between ETFs may be difficult because only a dozen have 10-year records, while 42 have only come into existence within the last 5 years.
Let’s now consider some of the most popular ETFs out there:
1. Vanguard FTSE Emerging Markets ETF (VWO:NYSE)
This well-known fund is one of the largest in terms of assets under management at $69.2 billion. It seeks to track the performance of the FTSE Emerging Markets All Cap China A Inclusion Index. This index is a market capitalization-weighted index that represents large, mid, and small-cap stocks of companies located in emerging markets around the world. It includes countries like Brazil, Russia, India, Taiwan, China, and South Africa, with China making up 44% of its holdings.
This fund uses index sampling and is passively managed. It invests substantially all of its assets in stocks included in the index. It holds a basket of around 5000 stocks and has a relatively low expense ratio of 0.1%. Its ten largest holdings make up about 25% of its total assets. These assets include Alibaba, Tencent Holdings, and Taiwan Semiconductor Manufacturing. Since its inception in 2005, it has achieved an average annual return of 4.5%. This fund may be a good fit if you are looking for broad market exposure with a low expense ratio.
2. iShares Core MSCI Emerging Markets ETF (IEMG:NYSE)
This ETF, launched in 2012, seeks to track the investment results of the MSCI Emerging Markets Investable Market Index, arguably the most popular index of international stocks. It manages $45.3 billion in assets and is well-diversified with a holding of 2500 large-, medium-, and small-cap equities. It boasts a low MER of just 0.13%.
Geographically, its top five countries include China, Taiwan, South Korea, India, and Brazil, with China accounting for 37% of its allocation. One significant difference between this ETF and Vanguard’s ETF is the inclusion of South Korea as an emerging market. Remember, South Korea has the 11th largest GDP in the world. As a result, the FTSE index considers it to be a developed market, whereas the MSCI index does not. South Korea makes up 12% of the fund’s geographic allocation.
iShares also offers a similar fund (EEM), which tracks the same index, but without including the riskier but more rewarding small- and microcap equities. For those seeking to mitigate the impact of foreign currencies relative to the U.S. dollar, there is a hedged version of EEM as well (HEEM).
3. SPDR Portfolio Emerging Markets ETF (SPEM: NYSE)
This ETF corresponds generally to the performance of the S&P Emerging BMI Index, which is a market capitalization-weighted index. It seeks to invest substantially all, but at least 80% of its assets, in securities and depository receipts based on securities comprising the index. It currently has $3.2 billion in assets under management and a low expense ratio of 0.11%.
This ETF offers broad market exposure ex-South Korea. It is a large-cap blend, with over 2100 stocks in its portfolio. It’s top five geographic allocations are Hong Kong at 29.8%, followed by Taiwan, India, China, and Brazil. This fund ranks in the 25th percentile within its peer group.
4. Schwab Emerging Markets Equity ETF (SCHE: NYSE)
Launched in 2010, this ETF is a relative newcomer to the emerging markets, but it has made significant inroads into a market dominated by its larger rivals. Like the Vanguard ETF, it tracks the FTSE Emerging Index but is comprised of mainly large- and mid-cap equities. It manages $5.1 billion in net assets and is well-diversified with about 1400 stocks. Its expense ratio is low at 0.11%.
It invests in over 20 emerging market countries, its top ones being China at 44%, followed by Taiwan, India, Brazil, and South Africa. This fund has delivered returns in line with most other emerging markets ETFs.
5. Emerging Markets Internet & E-commerce ETF (EMQQ: NYSE)
If you are looking to capitalize on the consumer story in emerging markets, then this ETF could be of interest to you. Unlike other ETFs, this one specifically focuses on an index of leading Internet and E-commerce companies. To be included, these companies must derive their profits from such activities as online retail, social networking, online gaming, online video, search engines, e-payments, and online travel. As more consumers in the developing world get their first smartphone, and the internet becomes cheaper and more accessible, rapid growth in online consumption in these countries is expected.
This fund was launched in 2014, and holds over 40 companies operating in 20 different markets. Its biggest allocation is to China at 60%, followed by South Korea, South Africa, Netherlands, and Argentina. The expense ratio is a little bit higher at 0.86%. However, this fund has generated impressive returns relative to other ETFs at a 5 year annualized rate of return of 6.1%. It has consistently been one of the top emerging markets ETFs since inception.
Before Taking The Plunge
We hope we have provide a beginner’s overview to investing beyond U.S. borders. Remember, when choosing an ETF, it is important to understand what the ETF is tracking and its underlying risks. Developing countries are more vulnerable to geopolitical and governance risks. Rather than focusing on one country, it may be better to look for diversification across many countries or to diversify across different ETFs in order to get a blend of countries and investing styles.
And with emerging markets, it is important to remember to take a long view approach, as these countries may be slow to progress. Given the volatile nature of emerging markets, you may also need to limit your exposure to a small percentage of your portfolio. While this may seem like a low-risk way to start investing, remember there is always some element of risk. This means you will need to conduct your own research before making any trading decisions. Happy investing!