There are two ETFs of particular interest due to their contrasting natures: Vanguard’s MSCI Emerging Markets ETF (VWO) and Wisdom Tree’s Emerging Markets Equity Income Fund (DEM). VWO has been widely used in part due to the size of the fund, holding $48.67 billion in assets. It also has a trading volume of 13,117,869 and a 30-day average bid-ask spread of $0.01. All of these things combined would give VWO a good tradability grade. In contrast, DEM is a much smaller fund with only $1.59 billion assets under management, 300,901 in trading volume, and a $0.50 bid-ask spread. Both ETFs are trading at a premium. Recently, VWO is trading at a 0.676% premium while DEM is higher at a 1.557% premium.Past Performance
The apparent bias for VWO over DEM cannot be explained by a superior performance. According to Morningstar reports released May 31, DEM performed better than VWO. Since VWO’s inception in May 2005, it has spent every year in the bottom two performance quartiles for its category. Although DEM can only fall back on three full years of historical data since its inception in July 2007, it has shown a more impressive finish. It made a top-quartile placement in 2008, suffered a dip to the second-lowest quartile in 2009, and recovered to the second-highest quartile in 2010. The graph below depicts the actual performance of the two funds against each other.
Country and Stock Diversification
As already mentioned, the greater diversity hypothetically means less risk. DEM, the arguably smaller of the two, has 628 total stocks in its holdings, while VWO holds 854 total stocks. The following tables show a percentage breakdown by country and by sector of each ETF's stocks.
VWO is heavily weighted in Asian countries, both emerging and developed, and has a little less than one-quarter of its holdings in Latin America. DEM has given one-quarter of its holdings to Latin American, another quarter to Asia developed, and around one-fifth each to Europe and Asia emerging. If a current portfolio already favors one of these regions, it may be of benefit to add the fund that will result in a more diversified regional balance. Some reports speculate that Latin American emerging markets, particularly Brazil, may have increasing influence on the world’s GDP in the next five to 10 years.
Another area to consider when trying to balance and diversify a portfolio is market capitalization, or size of holdings. Both VWO and DEM have the majority of their holdings in large-cap companies. However, VWO has allocated 84.45% of its stocks in giant and large-cap companies, while DEM only has 69.89% in giant and large-caps. VWO has little mid- and small-cap exposure, making it susceptible to downturns in large cap company market prices. DEM has allotted 21.25% of its stocks to be held in mid-cap companies, and 8.85% in small-caps.
Small-cap firms have the potential for rapid growth, but with added risk. Mid-cap companies offer greater stability than small-caps due to size, and higher growth potential than large-caps. We also find that large-cap emerging market companies are more closely aligned with global economies where mid- and small-cap companies selling locally are somewhat shielded from global issues. DEM offers better protection than VWO in providing more balanced exposure among all market asset classes.
Risk and reward can be measured by standard deviation and Sharpe ratio. The higher the standard deviation, the higher the risk. Based on a three-year period ending May 31, the standard deviation for VWO is 32.59, while DEM stands at 26.52.
The Sharpe ratio helps determine if there is enough reward to make the risk worthwhile. The higher the Sharpe ratio, the more worthwhile the risk. As of May 31, VWO had a three-year Sharpe ratio of 0.18, while DEM had a 0.42. Based on these numbers, DEM offers a higher reward potential for the risk taken.
Indexes and Style
VWO and DEM track different indexes in different ways. VWO tracks the MSCI Emerging Markets Index, which examines economic development, size, liquidity and market accessibility, and then weights its holdings based on their market capitalization. DEM has created a unique mix of companies by following the WisdomTree Emerging Markets Equity Index, which is actually assembled based on the highest 30% of dividend-yielding stocks from another index, the WisdomTree Emerging Markets Dividend Index. DEM offers some protection from the regular volatility associated with the emerging markets through dividends. As of June 29, DEM reports a dividend yield of 6.50, which is much higher compared to VWO with a 1.680 dividend yield.
Summary and Conclusions
VWO has a longer history and larger assets under management compared to DEM (roughly a 50/.1.5 ratio). It has a higher trading volume and lower bid-ask spread. VWO has a relatively higher number of holdings. However, VWO performance has trailed that of DEM.
VWO is heavily concentrated in Asia, both emerging and developed, while DEM is more evenly spread among four emerging market regions. VWO also has a significantly high concentration in giant and large-cap companies, with miniscule amounts in mid- and small-caps. DEM includes twice as much concentration in mid- and small-caps, as compared to VWO.
VWO has higher standard deviation than DEM, with a lower Sharpe ratio, indicating DEM offers a potentially higher reward for the risk undertaken. DEM also includes a much higher dividend.
For investors looking for liquidity or to add more Asian investments to their portfolio, VWO would be a good choice. For investors looking for greater diversity in region, market cap and style concentrations, DEM would be the better choice. From a pure analytical perspective, DEM offers potentially better return on the investment.