Investors who are interested in emerging markets exchange traded funds have a number of options for their portfolios aside from the heavily traded iShares MSCI Emerging Markets Index (NYSEARCA:EEM). Alternative emerging market strategies have shied away from the typical market-cap weighted index.
"First, the issue is far from academic (although it is academic as well). According to EDHEC Risk Institute, the amount of money in exchange-traded products has been growing at an annual rate of 30% a year, and sit at $1.4 trillion. Most of the cash, however, is in capitalization-weighted indexes, which has its critics. And in the emerging world it can be especially problematic," Ben Levisohn wrote for Barron's.
Emerging markets had finished out 2012 with gains, with EEM up almost 19%, however, 2013 has painted a much different picture for this sector. U.S. equities have rallied and investors have focused their attention back to domestic markets. EEM has seen outflows of $619 million this year, according to Birinyi Associates.
"Concerns about slowing growth in developing economies is likely one reason investors have pulled back from emerging-market issues," Carla Mozee wrote for MarketWatch.
"External headwinds - political and fiscal troubles in the euro zone and the U.S. among them - "may restrain the mighty [emerging market] growth engine," or, alternatively, the current slowdown "will prove temporary as the inventory cycle works its way through and improved underlying fundamentals bring back the days of strong growth," said Murat Ulgen, HSBC's chief economist for Central and Eastern Europe and sub-Saharan Africa, in its report."
Emerging Asia has been a hot region, which includes countries such as Singapore, Malaysia, Thailand and Indonesia. Better risk-adjusted returns have been achieved with equal-weight indices, those that give an equal allocation to every company held, versus weighting heavier toward the largest stocks.
The EDHEC report unveiled that the following equal-weight indices and related ETFs delivered better risk-adjusted than their large-cap peers: Nifty Fifty Index, South Korea's Kospi 200 Index and the Taiwan FTSE TWSE 50.
Another alternative is a dividend weighted emerging market index. The WisdomTree Emerging Markets Equity Income ETF (NYSEARCA:DEM) and the iShares Emerging Markets Dividend ETF (NYSEARCA:DVYE) are two choices. DVYE has outperformed the MSCI Emerging Markets Index with better risk-adjusted returns as well.
And for those investors who like to stick with a broad-based, large-cap strategy, there are more affordable alternatives to EEM. The Vanguard Emerging Markets ETF (NYSEARCA:VWO) and the iShares Core MSCI Emerging Markets Index ETF (NYSEARCA:IEMG) are less expensive than EEM and provide exposure to the major BRIC countries minus India. VWO costs 0.18%, IEMG costs 0.23%, compared to EEM at 0.67%.
"I'd argue that if you're a buy and hold investor with a long time horizon, you'd be willing to handle the extra volatility in exchange for an expense ratio that's less than half the cost of DVYE & friends," Brendan Conway of Barron's said.
iShares MSCI Emerging Markets Index
Tisha Guerrero contributed to this article.
Full disclosure: Tom Lydon's clients own DEM, EEM and VWO.