More on Emerging Market ETFs EEM vs. VWO

By Matthew Hougan

I want to add a few additional thoughts to our recent posts about emerging market ETFs.

First, a correction: The expense ratio for VWO is actually 0.25%, not 0.30%. That may be the most impressive of all the Vanguard expense ratios ... more impressive in some ways than offering the total U.S. market (VTI) for 0.07%. For 0.25%, you can buy everything from Chile to China. Amazing.

That said, for traders, liquidity is on the side of EEM. Both EEM and VWO have good liquidity, but EEM's is better. From July 1 through July 31, EEM had an average spread of just one penny, compared to 2 cents for VWO, according to ArcaVision. One penny may not seem like much, but multiply it out over a few thousand shares and it can overwhelm the expense ratio differential for short-term investors.

Lastly, and most importantly, I'd take either of these funds over the active choices that are out there.

I was recently setting up a new retirement account with a service provider that does not offer an emerging markets index fund. You can buy ETFs through this provider, but you have to pay a brokerage fee, which doesn't make sense until you build up assets in the account.

I'm a big believer in emerging markets over the long term, so I had to make an allocation to the space. Frustrated, I started sorting through the available active funds looking for one to buy. A few impressions ...

First, the costs will get you. I set my search parameters for emerging markets funds with expense ratios of less than 1%; the query returned zero results. The cheapest fund started at 1.1%, and prices went up from there. And there were hundreds and hundreds of funds on this platform.

Second, I have no idea how people choose actively managed funds. There were a dozen of emerging market funds from a half-dozen fund providers, and finding out more than the expense ratios, annual returns and Morningstar STAR rating was very difficult. I felt like I do in the supermarket cereal aisle, when I just want to buy cornflakes, but everything I see has marshmallows, dehydrated fruit and a free Tickle-Me-Elmo toy. And they all cost $5.95/box. It's hard enough sorting through 700 ETFs; I can't imagine how most investors do it with 8,000 mutual funds.

For the record, I ended up buying the lowest-cost, most broadly diversified emerging markets fund I could find: A relatively low-cost emerging markets fund from Fidelity. I'm not happy about it, though: The beta is too high and some of the stock positions are too concentrated. As soon as the assets build up, I'm switching over to VWO. Or maybe EEM, if they bring the price down.

Comments

[ETF Guy:]

I've been in EEM for years. I can't remember how I heard about EEM before VWO. I like to think that I did some thorough research, but in the end it could just as easily be that I was already in other iShares and picked up EEM out of convenience. So much for being rational... :-)

2008 Aug 23 08:52 PM

[LLuke:]

Good analysis. The ETF is the way to go. It's comprehensive coverage, it's simple and it's much cheaper. And they beat most of the managed funds anyway.

2008 Aug 26 06:11 PM

[E*Wade:]

Over the long haul (8+ years), Actively Managed Open-End Emerging Market Mutual funds have AVERAGED more than 300 basis point returns over indexing, which far outweighs the cost of 50 to 100 basis points in expenses. Sure, low cost Developed Market ETF's are a no-brainer, but I'm not sure I'm ready to trust political risk, purchasing power risk, currency risk, et cetera, inherent in emerging market investing, to indexing. Lack of transparency in those lesser known markets make the cost of active management worthwhile. Lastly, choosing a fund company with vast research and management resources is vital to going the active management route. Fidelity's Diversified International & Emerging Markets Funds are two standouts. Cheers!

May 08 05:40 PM