Which Emerging Markets Index Is Best?

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Includes: EEM, IEMG, SCHE, VWO
by: Strubel Investment Management
Summary

There are substantial differences between the four largest emerging market index funds.

All four funds follow a different index.

Each fund has substantial variations between country and sector weightings.

With the US stock market trading at a P/E of around 24, international developed markets at around a P/E of 16, emerging markets are one of the cheapest equity asset classes (with a P/E of around 15). However, not all emerging market ETFs are created equal. In this article we'll go over some of the subtle differences between the four largest emerging market ETFs. We'll look at Vanguard FTSE Emerging Markets ETF (VWO) with $68B in assets, iShares Core MSCI Emerging Markets ETF (IEMG) with $45B in assets, iShares MSCI Emerging Markets ETF (EEM) with $41B in assets, and Schwab Emerging Markets Equity ETF (SCHE) with $5B in assets.

All of the ETFs are low cost with virtually identical annual expenses. Schwab charges .13% annually while all of the rest charge .14%. For most investors a .01% is going to be a rounding error (if you have a $1M portfolio with a 10% emerging market exposure you are looking at just a $100 difference in fees). For most investors the deciding factor on which emerging market ETF belongs in their portfolio is going to be some of the subtle differences in the indexes each fund tracks.

The funds along with the index they track and the number of holdings are shown below. Data is as of 12/31/2017 except for the iShares funds which are as of 2/9/2018.

Ticker

Index Tracked

Holdings

VWO

FTSE Emerging Markets All Cap China A Inclusion Index

4734

IEMG

MSCI Emerging Markets Investable Market Index

1917

EEM

MSCI Emerging Markets Index

862

SCHE

FTSE Emerging Index (Net)

909

So, let's look at some of the important differences.

What is South Korea?

Well, we all know it's the country currently hosting the Winter Olympics but beyond that FTSE and MSCI aren't in agreement what it is. The MSCI indexes consider South Korea to be an emerging economy and include it in their emerging market indexes. So, both IEMG and EEM have about 14.5% of their fund allocated to South Korea while VWO and SCHE have 0% weightings. Given that South Korea is the 11th largest economy (it's ranked about the same spot by stock market capitalization as well), has a stable political system, and well developed capital markets it's categorization as an emerging economy seems questionable to us. Indeed, South Korea's economy is larger than Spain and Switzerland which are both considered developed markets.

Of course, a country's index categorization has little actual fundamental effect. The big issues for investors is that if you choose a emerging markets fund that includes South Korea you'll need to then choose a developed markets fund that excludes South Korea if you are aiming for market weighting in your portfolio. (If you want to be overweight South Korea then you could choose a developed markets fund that includes it.) As you might guess the FTSE based indexes like Vanguard's Developed Markets ETF (VEA) include South Korea while the MSCI based ones such as the iShares MSCI EAFE ETF (EFA) do not.

How the Indexes Handle China

The second biggest difference between the indexes is how they handle China. The table below shows the relative weighting for each country (excluding South Korea) among the four funds.

Data for VWO and SCHE from 12/31/17, IEMG and EEM from 2/9/18.

Country

VWO

IEMG

EEM

SCHE

China

32.6%

27.63%

29.71%

30.83%

Taiwan

14.4%

11.96%

11.31%

13.03%

India

11.8%

9.30%

8.53%

11.85%

South Africa

7.9%

6.65%

6.74%

9.03%

Brazil

7.7%

7.05%

7.36%

8.43%

Thailand

3.8%

2.59%

2.4%

3.62%

Russia

3.6%

3.14%

3.52%

4.15%

Malaysia

3.3%

2.49%

2.36%

3.19%

Mexico

3.3%

2.93%

2.99%

3.68%

Indonesia

2.4%

2.29%

2.28%

2.48%

VWO has the highest weighting for China by virtue of the fact that it tracks an index that includes Chinese A Shares which are renminbi denominated shares traded on the Shanghai and Shenzhen stock exchanges. SCHE has the next highest weighting for China by virtue of the fact that South Korea is excluded (thus raising the relative weights of the other larger markets). However, SCHE does not include a China A shares. IEMG has the lowest weighting for China because it includes small cap companies, which make up a disproportionate amount of stocks outside of China.

Once you get past about the top five countries by weight the differences between the four funds become negligible. For instance, a .11 percentage point difference in the weight of the Indonesian stock market is not going to drive large differences in returns where as a 5 percentage point difference in the weighting of the Chinese market very well could.

Country Weightings Change Sector Weightings

The difference in country weightings also translates into a difference in sector weightings. This is largely because of the high concentration of financials in China and technology companies in South Korea.

The table below shows the relative sector weightings by ICB industry for VWO and IEMG (we are showing just two funds since SCHE follows a similar index as VWO and EFA is similar to IEMG). We also added the Russell 3000 weights so you can see how they differ from the US market as well.

ICB Industry

VWO

IEMG

Russell 30000

Oil & Gas

7.29%

6.64%

5.59%

Basic Materials

7.37%

7.86%

2.68%

Industrials

10.75%

6.23%

13.31%

Consumer Goods

9.04%

6.14%*

8.76%

Health Care

2.82%

2.75%

12.53%

Consumer Services

10.26%

10.66%*

13.08%

Telecommunications

4.56%

4.14%

1.80%

Utilities

3.15%

2.45%

2.76%

Financials

29.58%

25.63%

20.03%

Technology

15.16%

25.81%

19.36%

*Consumer services includes auto and auto parts businesses which are categorized as consumer goods by ICB.

The FTSE index funds like VWO and SCHE have a higher weighting in financial and a lower weighting in technology. Beyond that, the other significant difference is a higher weighting in industrials for the FTSE funds like VWO and SCHE.

The other weighting issue that makes the merging market index funds attractive is that they all include substantial weights for technology stocks. Most developed market indices, which exclude the US, have very small weights in technology. For example, the FTSE Developed All Cap Ex-US Index has only an approximate 4.5% in technology stocks. Keep in mind this is an index which includes the tech heavy South Korea market. MSCI Developed Markets Indices will be even more underweight technology.

Summary

In the end none of the differences between the funds render any of them objectively better than the other. They are simply different, and the best one is whichever fits your investment goals the best. For myself and for our clients we use both VWO and SCHE as Vanguard and Schwab have consistently shown their dedication to keeping ETF fees low and accounting for South Korea as a developed market makes more sense to us.

Disclosure: I am/we are long SCHE, VWO. 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.