Have Low-Volatility Emerging Market ETFs Delivered?

| About: iShares Edge (EEMV)

Summary

Performance discrepancy between U.S. and emerging-market stocks have widened over the past 18 months.

Emerging-market stocks are much cheaper than U.S. stocks.

EEMV delivered higher returns and lower volatility compared to EEM.

Low volatility funds have been all the rage lately, with the PowerShares S&P 500 Low Volatility ETF (NYSEARCA:SPLV) leading the SPDR S&P 500 ETF (NYSEARCA:SPY) by some 1300 basis points year to date.

SPLV Total Return Price Chart

SPLV Total Return Price data by YCharts

How about non-U.S. low volatility funds? Around 18 months ago, I introduced three low volatility emerging market [EM] ETFs (A Comparison Of 3 Emerging Market Low Volatility ETFs). One of these, the ETF formerly known as EGShares Low Volatility EM Dividend ETF, changed investment mandate to focus on quality dividends, and is now known as the EGShares EM Quality Dividend ETF (NYSEARCA:HILO).

The remaining two low volatility EM ETFs are the PowerShares S&P Emerging Markets Low Volatility Portfolio (NYSEARCA:EELV), which tracks the S&P Emerging BMI Plus LargeMid Cap Index and iShares MSCI Emerging Markets Minimum Volatility (NYSEARCA:EEMV), which tracks the MSCI Emerging Markets Minimum Volatility Index. How have they performed in the last 18 months?

Performance

Their total return performance over the since my last article was published is shown below, together with the benchmark iShares MSCI Emerging Markets ETF (NYSEARCA:EEM).

EEMV Total Return Price Chart

We can see that the two low volatility EM funds have pretty much moved in lockstep with the benchmark, with EEMV coming out slightly ahead at -5.43% over the past 18 months, compared to -10.6% for EELV and -9.45% for the benchmark EEM. As I mentioned in my Dec. 2014 article, EEMV was my favorite low volatility EM ETF out of the three, and it is pleasing to see that it has outperformed both EELV and EEM since then. (Interested readers may refer to "In Defense Of iShares MSCI Emerging Markets Minimum Volatility ETF" for a rebuttal to another author's critique of this fund).

Volatility

As shown in the chart below, both EEMV and EELV have succeeded in their investment mandate of low volatility. Both funds were less volatile than the benchmark over the past 18 months, with EEMV being slightly less volatile than EELV.

EEMV 30-Day Rolling Volatility Chart

EEMV 30-Day Rolling Volatility data by YCharts

The lower volatility of the two EM funds across several metrics over the past two years is corroborated by data from InvestSpy. The data also confirms that EEMV is slightly less volatile than EELV.

Ticker Annualized Volatility Beta Daily VaR (99%) Max Drawdown Total Return
EEM 21.1% 1.13 3.1% -36.0% -18.3%
EEMV 15.8% 0.85 2.3% -28.9% -11.3%
EELV 17.3% 0.89 2.5% -34.9% -18.3%
Portfolio 17.8% 0.96 2.6% -32.9% -15.9%
SPY 14.8% 1 2.2% -13.0% 12.4%
Click to enlarge

Valuation

With U.S. low volatility stocks becoming slightly overvalued, investors may be concerned about whether the same is happening to EM low volatility stocks. The following data shows the valuation and growth metrics for the three EM funds, together with SPY as a comparison (source: Morningstar).

EEMV EELV EEM SPY
Price/Earnings 14.84 13.37 12.10 18.46
Price/Book 1.86 1.40 1.28 2.59
Price/Sales 1.41 1.35 1.10 1.81
Price/Cash Flow 4.30 4.3 3.91 10.08
Dividend Yield % 3.73% 3.81% 3.67% 2.35%
Projected Earnings Growth % 9.28 10.09 12.17 8.79
Historical Earnings Growth % 4.64 1.63 -64.75 5.81
Sales Growth % 4.06 -0.06 -10.77 1.55
Cash-flow Growth % 3.64 5.42 5.77 1.36
Book-value Growth % 4.47 5.03 -23.3 3.11
Click to enlarge

We can see from the above chart that EEMV and EELV are indeed a bit more pricey than EEM, similar to what was observed for these funds 18 months ago. However, all three EM funds are significantly cheaper than SPY.

Overlap

The below table (source: ETF Research Center) shows that the two low volatility EM funds have only 35% overlap. EEM has 29% overlap with EEMV and 24% overlap with EELV.

EEM EEMV EELV
EEM - 29% 24%
EEMV - - 35%
EELV - - -
Click to enlarge

Geographical distribution

The top five country weights for each ETF is listed below (source: ETFdb):

  • EEM: China (26%), South Korea (15%), Taiwan (12%), Malaysia (8%), Thailand (6%)
  • EEMV: China (21%), Taiwan (17%), South Korea (11%), India (8%), Brazil (7%)
  • EELV: Taiwan (20%), Malaysia (15%), Mexico (11%), Thailand (10%), South Korea (7%)

Analysis of the above weights show that EEM is the most Asian-focused fund, with all top 5 country weights coming from Asia. EEMV has Brazil as its 5th largest country weight while for EELV, Mexico comes in at 3rd place. The most striking feature about EELV is that China only takes up 3% of its portfolio.

Discussion and outlook

Since my previous article on the low volatility EM funds 18 months ago, the performance discrepancy between U.S. and EM stocks has widened even further:

SPY Total Return Price Chart

The total return of U.S. stocks since the financial crisis is now nearly triple that of EM stocks:

SPY Total Return Price Chart

EM equities are even cheaper now than 18 months ago (source: Morningstar):

On the whole, EM stocks are 34% cheaper than U.S. stocks on a P/E basis, 51% cheaper by P/B, 39% cheaper by P/S and 61% cheaper by P/CF. Will this low valuation eventually lead to higher returns for EM stocks?

Of course, the low volatility EM ETFs highlighted here are a bit more expensive than the broad market EEM, but they are still considerably cheaper than domestic stocks.

The BAML survey of global fund managers has indicated that managers are just now rotating into EM equities after over a year of being underweight in this region. This could be viewed either as an indicator of upward momentum, or alternatively as a contrarian signal.

EEMV remains my preferred choice for an investor who wishes to obtain some emerging market exposure, but with lower volatility. I am less keen on EELV due to its weaker historical performance and its surprisingly low allocation to China, which I think is sub-optimal.

Disclosure: I am/we are long EEMV.

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.