Twenty years ago, the very first ETF was introduced to the investment community. That exchange-traded fund, the SPDR S&P 500 ETF (NYSEARCA:SPY), remains both a popular and widely-owned ETF with roughly $138 billion in total net assets and monthly volume measured in the billions of shares. According to the Investment Company Institute's 2013 Investment Company Fact Book, a decade after the launch of SPY, the number of ETFs had grown to 119. At the time, some investors might have viewed 119 ETFs as being more than sufficient to cover the various parts of the financial markets. But everyone wanted a piece of the ETF pie.
From 2003 onward, growth in both the number of ETFs and the total net assets of ETFs exploded. In just three years, the number of ETFs more than tripled, jumping to 359. Then, from 2006 to 2011, the number of ETFs available to investors more than tripled again, rising from 359 to 1,134. Between 2003 and 2011, the total net assets of ETFs grew from just $151 billion to slightly more than $1 trillion. Fast forward to 2013, and, as of the end of April, there were 1,209 ETFs with $1.469 trillion in assets. Of the 1,209 ETFs, 576 are considered domestic equity, 408 are international equity, 211 are bond funds, and 14 are hybrids of equity and fixed-income. With all those ETFs available to choose from, it is understandable that some investors may struggle to pick the right one(s) for their portfolios.
Among the multitude of ETFs investors can choose from, there are many that look strikingly similar. In this article, I would like to examine three such ETFs from the international equity category. More specifically, all three ETFs track the performance of emerging markets stocks. As previously mentioned, as the popularity of ETFs grew, everyone wanted a piece of the pie. Two ETF families, Vanguard and BlackRock's iShares, have been quite successful in raising investor interest for their ETFs. In the emerging markets space, Vanguard offers the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO). iShares also offers emerging markets exposure through its ETFs, two of which are the well-known iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) and the lesser known iShares Core MSCI Emerging Markets ETF (NYSEARCA:IEMG).
If you have been looking for a great example of extremely similar ETFs, look no further than VWO, EEM, and IEMG. All three have China as the largest single country exposure. Regarding country diversification, in addition to China, Brazil, Taiwan, South Africa, Russia, Mexico, and Malaysia all appear in the top 10 for VWO, EEM, and IEMG. Also, in each case, Taiwan Semiconductor Manufacturing (NYSE:TSM), China Construction Bank (OTCPK:CICHY), and China Mobil (NYSE:CHL) are represented in the top four holdings. There are also plenty of other examples of overlap among the holdings. Essentially, VWO, EEM, and IEMG each track a broad basket of emerging markets stocks, and because they at first glance appear so similar, some investors might not give careful enough consideration as to which of the three is most appropriate for their portfolios. But despite striking similarities, EEM, VWO, and IEMG do have slight differences.
7 Important Differences Among EEM, VWO, and IEMG
1. In 2012, when Vanguard announced it would make the switch from its funds tracking MSCI indexes to tracking FTSE indexes, it was the beginning of the end for VWO's South Korean exposure. Since FTSE does not classify South Korea as an emerging market, it meant VWO would need to unwind a position of roughly 15% of the fund. The unwind is well underway, and, as of May 31, 2013, VWO's allocation to South Korea stood at just 2.6%. That compares to 14.6% and 14.81% allocations for EEM and IEMG respectively (as of June 13, 2013). If you want your emerging markets exposure to include South Korea, VWO is not the fund for you. Of course, in the future, MSCI could decide to reclassify South Korea from an emerging market to a developed market. Doing so would cause the removal of South Korean exposure from EEM and IEMG. In fact, South Korea is currently under review for a reclassification as part of MSCI's "2014 Annual Market Classification Review." The final decision on whether the country is reclassified will be announced in June 2014.
2. EEM's expense ratio is notably higher than VWO's and IEMG's. The 66 basis points expense ratio for EEM compares to just 18 basis points for VWO and IEMG. For expense-focused investors who want exposure to South Korea, this gives the edge to IEMG. On the other hand, expense-focused investors who don't believe South Korea is an emerging market would likely be drawn to VWO.
3. As of May 31, 2013, IEMG's 30-day SEC yield stood at 2.98%. On the same date, EEM's was just 2.11%. Vanguard does not share VWO's SEC yield. But using last year's distributions of $0.975 and conservatively assuming no dividend growth in 2013, the yield would currently be around 2.45%. Higher expenses and a lower yield certainly is not a positive for EEM.
4. One area that is a positive for EEM is options trading. If you are interested in trading options on an emerging markets ETF or trading around a core position in an emerging markets ETF, EEM has the most liquid option chain of the three. VWO is clearly second, however, with what I think is acceptable liquidity and a sufficient number of expiration dates to choose from. IEMG is without a doubt in third place when it comes to option chain liquidity and available expiration dates. If you are interested in ways options can help increase your income, generate capital appreciation, and get you out of losing emerging markets positions (there are plenty of those nowadays), my newly published book, Options Strategies Every Investor Should Know, will be a great resource. Especially if you feel "stuck" in a losing position given the recent underperformance of emerging markets ETFs, there is one actionable idea in particular presented in my book that uses options to lower exposure to a losing position without having to realize a loss.
5. In terms of the number of stocks each ETF holds, IEMG has more than double what EEM holds (1,762 versus 829). VWO is somewhere in the middle with 1,032 stocks in the portfolio. If you are looking to be diversified across the greatest number of companies, IEMG is the clear winner. With that said, the top 10 holdings in IEMG do still make up nearly 14% of the fund, compared to roughly 16% for EEM and VWO. So while IEMG does have significantly more stocks in its portfolio, it does not necessarily mean it has significantly less exposure to its top holdings.
6. Expense-focused investors should also pay attention to commissions. If you want to purchase VWO at Vanguard, there are no commissions. This works great for investors looking to average into a position over time. If you want to build a position in IEMG at Fidelity, there are no commissions. EEM, on the other hand, was dropped from Fidelity's commission-free iShares lineup. Therefore, if you are planning to make several purchases of an emerging markets ETF at Fidelity, the combination of lower expenses, a higher yield, and no commissions tips the scale in favor of IEMG despite the better options liquidity for EEM.
7. Last but certainly not least, the amount of Qualified Dividend Income (QDI) is an important difference between some ETFs. If you want to own EEM, VWO, or IEMG in a taxable account, pay close attention to the amount of the ETF's annual dividend that qualifies as QDI. In 2012, just 57.37% of VWO's dividends qualified for the preferable tax rates on dividends. On the other hand, 77.33% of EEM's dividends qualified for the preferable dividend tax rates. IEMG's inception date was October 18, 2012. Given this, I don't trust that last year's 100% of dividends being considered QDI will carry over to 2013.
I agree with the notion that each investor's situation is unique. In addition to risk tolerance and time horizon, an investor may have a whole range of other circumstances that make one particular emerging markets ETF more appropriate than another. For example, an investor wanting from an emerging markets ETF exposure to South Korea and a liquid options chain would likely favor EEM over VWO or IEMG. But an investor focused on lower expenses who also wants to use options to generate additional income would likely favor VWO. An investor who simply wants as much diversification as possible across stocks and favors higher dividend yields would likely favor IEMG. And, of course, Vanguard and Fidelity clients might also use commission-free trades as a determining factor in their decisions.
Finally, remember that just because several ETFs may have names that make them sound virtually identical does not mean they are. Upon careful examination, you may discover that one ETF in particular may be far more suitable for your portfolio than the others. When selecting the most appropriate ETF for your emerging markets exposure, keep in mind the seven differences outlined in this article. And even if you are considering an emerging markets ETF other than EEM, VWO, or IEMG, the seven differences discussed in this article can serve as a helpful resource for your research.
Disclosure: I am long VWO, CHL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.