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The relative strength models I use eliminated their exposure to emerging markets some time ago. But after a sharp correction, it is possible that the emerging markets may begin performing well again in the near future. In order to get ready, I did an analysis today to select the most appropriate diversified emerging market ETFs to use.

I use the XTF ETF Experts product which has a structural integrity analysis that gives a good overview of the trading efficiency of any ETF. The Structural Integrity analysis consists of seven factors, but I focus on the following four factors in tax deferred retirement accounts:

  • b. Efficiency: daily alpha before expenses
  • c. Market Impact
  • f. Expense Ratio
  • g. Bid-Ask Ratio

These factor values are calculated and subsequently ranked on a percentile basis to rate each ETF with respect to all other ETFs within the same asset class. For every factor, each ETF is ranked by percentile such that the highest-ranking ETF in its class receives a 100 and the lowest-ranking ETF receives a zero. For more information about the XTF factor values, see my previous post where I compared some small cap value ETFs.

Using the overall XTF ratings, the top three ETF’s for diversified emerging market equities are VWO, ADRE and EEM. I eliminated GMM and GSR because of low average trading volume.

Here is a summary of the key factors I look at from the XTF system. I have highlighted in boldface the higher rated ETF for each factor.

VWO Percentile
Overall XTF Rating 6.6
Expense Ratio 0.27% 82.40%
Avg Bid-Asked Ratio 0.02% 93.60%
Market Impact 0.10% 96.60%
Efficiency -1.01 27.00%
Premium (Discount) -0.24%
Avg Trade Size 342
Avg Daily Volume 14,098,474
EEM Percentile
Overall XTF Rating 5.1
Expense Ratio 0.72% 23.10%
Avg Bid-Asked Ratio 0.02% 94.00%
Market Impact 0.04% 99.40%
Efficiency -1.75 19.70%
Premium (Discount) -1.02%
Avg Trade Size 615
Avg Daily Volume 78,872,966
ADRE Percentile
Overall XTF Rating 6.5
Expense Ratio 0.30% 77.20%
Avg Bid-Asked Ratio 0.06% 67.80%
Market Impact 0.87% 67.00%
Efficiency 0.88 83.00%
Premium (Discount) 0.03%
Avg Trade Size 343
Avg Daily Volume 171,928

For the 8 data points I looked at, EEM was highest on five factors, mainly those related to trading liquidity. VWO was the leader on two factors, but was a close second to EEM on trading liquidity. ADRE was the leader in Efficiency, but was in last place for the trading liquidity factors.

I decided to select VWO for my intermediate term trading models. It has the highest overall XTF rating, and pretty high rankings in all categories except for Efficiency, but it still has a higher Efficiency rating than EEM.

For short-term mean reversion models, I would choose EEM, since the higher expense ratio is less of an issue for very short holding periods, but trading liquidity is critical.

If I were to select an ETF for long term investment, I would consider using ADRE because of its high Efficiency score, but I would not use it for models that trade several times a year.

Full disclosure: No position in any of the above securities.

Source: Choosing an Emerging Market ETF