Another Case for Emerging Markets ETFs

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 |  Includes: AGEM, DEM, EWX
by: Michael Johnston

All indications are that the global recession ended long ago and a recovery is now well underway. But storm clouds remain over much of the global economy, preventing green shoots from taking root. The economic hurdles in the developed world are both numerous and significant. The number of unemployed Americans continues to rise. Europe is teetering dangerously on the brink of a sovereign debt crisis that threatens to undermine the common currency system. Japan continues to battle deflation as a stubbornly strong yen weighs on export markets.

These dismal predicaments in industrialized nations stand in sharp contrast to the stories unfolding in the world’s emerging markets. China’s primary concern is growing too quickly, as a sustained boom threatens to overheat the economy. Malaysia recently raised interest rates for the second time this year, as the Central Bank attempts to curb inflation after GDP grew more than 10% in the first quarter. Singapore reported mind-boggling annualized GDP growth of 32.1% in the first quarter, proving that Asia’s economic boom boasts considerable depth.

Last week, the International Monetary Fund (IMF) released its most recent assessment of the global economy, drawing some interesting distinctions between the advanced and emerging economies in the process. Among the findings in the study (pdf):

  • The average gross debt-to-GDP ratio for advanced economies is projected to rise from about 91% at the end of 2009 to 110% in 2015, bringing the increase from pre-crisis levels to 37 percentage points
  • Among the G-7 nations, the debt-to-GDP ratio is rising to levels exceeding those that existed following World War II.
  • In emerging economies, debt-to-GDP ratios are projected to resume a gradual decline in 2011 thanks to sustained growth and relatively low interest rates.
  • In emerging G-20 economies, public debt in 2015 is projected to be almost 5 percentage points of GDP lower than before the crisis, despite the fact that interest rates will be consistently higher than those in developed markets.

With fiscal flexibility becoming an increasingly important consideration to investors, the IMF’s projections score another point for emerging markets. Trading inefficiencies and lack of complete transparency in many emerging markets certainly merit additional risk premia. But in an environment where the US government owns major stakes in everything from carmakers to banks and the eurozone currency is on life support, some investors have begun to question the relative positioning of developed and emerging markets on the risk spectrum.

Emerging Markets ETFs

ETFs have emerged as one of the most popular ways to establish exposure to developing economies; the emerging markets equities category now includes 43 ETFs with more than $70 billion in assets. Most of these assets are in VWO and EEM, two funds linked to the MSCI Emerging Markets Index. Below, we profile three other ETFs offering unique exposure to emerging markets:

  • Dow Jones Emerging Markets Composite Titans Index Fund (EEG): This ETF offers “pure play” exposure to emerging markets, avoiding the quasi-developed nations of South Korea, Taiwan, and Israel in favor of more BRIC-intensive exposure.

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  • WisdomTree Emerging Markets Equity Income Fund (NYSEARCA:DEM): This ETF is linked to a fundamentally-weighted index that measures the performance of the highest dividend-yielding stocks in emerging markets. As such, DEM has a different sector breakdown compared to EEM (less energy and financials, more consumer goods and services).

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  • SPDR S&P Emerging Markets Small Cap Index Fund (NYSEARCA:EWX): While most emerging markets ETFs are tilted towards mega cap companies, EWX focuses exclusively on small caps. This ETF tracks the S&P Emerging Markets Under USD 2 Billion Index, and makes the largest allocations to the economies of Taiwan, China, India, and South Africa (these four account for about 60% of holdings).

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Disclosure: No positions