Introduction
There are many ways to invest in Emerging Market stocks, each with different risk/reward profiles. The highly skilled can pick the best individual stocks, foregoing the other choices provided by professional investment sponsors. Depending on the number of stocks chosen, going it alone probably has the greatest risk/reward spectrum. Even within the fund arena, there is a wide range of risk levels investors can choose from. While others might rank these differently, here is how I view some choices, lowest-to-highest risk:
- Index-based ETFs/MFs.
- Non-Index-based ETFs/MFs.
- Single Country focused ETFs.
- Closed End Funds ranked by leverage employed.
After a strong run in 2020 and due to its current correction, I would rate Schwab Emerging Markets ETF (NYSEARCA:SCHE) as Neutral. Emerging Market stocks appear to move in streaks so the current weakness might be just starting.
Reviewing the Statistics behind EM countries
CFI uses the following definition and explains the importance of EM countries to the world's economy and future GNP growth.
An emerging market economy refers to a country that is in the process of developing its economy to become more advanced. It generates low to middle per capita income and is rapidly expanding due to growing populations, high production levels and significant industrialization.
Emerging market economies in developing countries are essential in driving global economic growth. Currently, emerging market countries generate more than 50% of the world's economic growth. By 2050, it is predicted that the top three largest economies will be China, India, and the United States.
Source: corporatefinanceinstitute.com
Of the roughly 200 countries on the planet, 80% are considered Emerging or Frontier. Emerging market economies make up 80% of the world's population, 59% of the world's GNP, and almost 70% of the world's GNP growth.
Economist at Morgan Stanley are currently providing the following forecasts to their clients.
Source: morganstanley.com
The article lists three key reasons to support their forecast:
- synchronized global growth,
- an emerging-market rebound,
- the return of inflation.
In a world that is highly intertwined by trade, Wall Street insists on categorizing companies by where they were founded, incorporated or headquartered. Having worked as a data analyst for a large pension investment manager, for some companies those data points meant three different countries and different clients wanted the same stock classified against different ones of those data points. I say all that as index providers do the same as South Korea is either a Developed (FTSE) or an Emerging (MSCI) country. That is a long-winded way of saying the first Morgan Stanley point is critical to EM-based companies as they live or die based on worldwide trading, especially the larger ones held by most EM-focused funds.
Source: think.ing.com
Rapid vaccination rollout and record levels of economic stimulus in Developed countries has resulted in the IMF increasing their forecasts for growth over the next two years. The rest of the world still has to catch-up on vaccination rates and most look for IMF stimulus as they cannot afford what the US and Europe have provided to their own countries. Developed country economic strength is important to EM companies dependent on exports.
For more Emerging Market data, read Emerging Markets - Powerhouse of global growth by Ashmore Group from 2018.
What Schwab Emerging Markets ETF provides investors
Seeking Alpha describes SCHE as
Schwab Emerging Markets Equity ETF is an exchange traded fund launched and managed by Charles Schwab Investment Management, Inc. It invests in public equity markets of global emerging region. It invests in stocks of companies operating across diversified sectors. It invests in growth and value stocks of companies across diversified market capitalization. It seeks to track the performance of the FTSE Emerging Index. SCHE started in January 2010.
Source: seekingalpha.com
SCHE has $9b in AUM with a 11bps expense ratio. The 30-day SEC yield is 1.53%.
SCHE Index review
Before diving deeper into the actual ETF, it is important to review and understand the index they use. For EM ETFs, this is extra critical, as mentioned earlier, index providers do not define each country the same. Crossing index providers could result in totally missing a country like South Korea, or double weighting it. SCHE does not invest in South Korea because of the FTSE index used.
The FTSE Emerging Index provides investors with a comprehensive means of measuring the performance of the most liquid Large and Mid Cap companies in the emerging markets. FTSE Emerging Markets indexes are part of the FTSE Global Equity Index Series (GEIS). The series includes large and mid cap securities from advanced and secondary emerging markets, classified in accordance with FTSE's transparent Country Classification Review Process.
Source: research.ftserussell.com
The FTSE document list these important features of the Index:
- The index is reviewed in March and September.
- The index includes about 1800 securities across 24 countries.
- The average market-cap is $3.9b.
Here are the current countries with stocks in the Index:
Source: research.ftserussell.com
As we will see when looking at SCHE's holdings, even though this index excludes China "A" shares that MSCI includes in their indices, China and Asia still dominate the index and thus the ETF.
SCHE ETF review
Fidelity provides a long list of statistics for the ETF and its comparisons to other funds within the same class.
Source: screener.fidelity.com
Higher scores are better so its low Efficiency score required me to check that definition out. Fidelity defines that as:
Efficiency quantifies how well an Exchange Traded Product outperforms its stated index/benchmark as a measure of excess profit or loss relative to the index/benchmark. The higher the efficiency the better as it illustrates the fund manager's aptitude of including higher returning securities in the fund's portfolio.
Not sure that measure would accurately apply to an ETF that follows an index that has limited control over the stocks chosen or the weights used. The equity statistics seem to indicate that many of the stocks would be classified as Value stocks. So let's take a look at where SCHE is invested.
Source: screener.fidelity.com
So even with South Korea and the China "A" shares excluded, Asia accounts for the lion's share of the regions covered with China being the largest individual country. Despite African economies expected to be the fastest growing over the next decade, only South Africa and Egypt are included in the underlying Index. This is due to the fact, if classified at all, most African countries like Nigeria and Morocco, are considered Frontier Market economies, those below Emerging Market status.
Source: screener.fidelity.com
Consumer Discretionary being at the top is no surprise with Chinese stocks being the highest percent own. With the largest consumer market in the world and exporting goods to the largest economy in the world, this seems logical. Financials being second also makes sense as large banks dominate the local stock market in many of these countries. That sector, along with most of the lighter held sectors, are more dependent on the strength of the local economy than say Technology or Materials might be.
Source: schwabassetmanagement.com
Based on the tickers or currency listed, again as expected, all the Top 10, which represent about 30% of the AUM, are from the Asian region except for Naspers, which is a South African internet provider. One risk investors need to monitor is the SEC action to delist Chinese companies from US exchanges. While that should only effect holdings like JD.com, an ADR, ETF holdings of banned companies could become a target next.
Seeking Alpha has added five grades for US ETFs, now available to subscribers.
The only poor grade, Momentum, is the main reason for my current Neutral rating as Emerging Markets trend to swing, not gently move most of the time; at least based on my chart reading. The other four grades indicate an ETF worth investigating deeper.
Portfolio Strategy
Ignoring 80% of the world's consumers who live in an EM country could prove costly in the long-run. For international investors, Emerging Market stocks have outperformed their Developed Market counterparts since 1996. For US investors, they provide risk diversity as they are only correlate to the US markets at 77%.
While I rate Schwab Emerging Markets ETF (SCHE) as Neutral now, they still provide diversification benefits that justifies some exposure as trend reversals are hard to predict.
As mentioned at the start, there are many ways to invest in Emerging Market stocks. Some recent articles on Seeking Alpha provide some variations.
- ADRE: Using ADRs To Invest In Emerging Market Stocks
- DEM: WisdomTree Emerging Markets High Dividend ETF
- EMXC: Putting A Wall Around China With The EMXC ETF
- XSOE: WisdomTree Emerging Markets ex-State-Owned Enterprises
- EMF: This CEF Will Deliver In The Next Emerging Markets Boom
Beside these, there are country-specific ETFs to pick from and various other Mutual Funds and Closed-End Funds that are not index-restricted or use Factors to build their universe. Two sites I checked listed over 80 funds, not counting MFs, in this space.
Final Thoughts
The purpose of Seeking Alpha is to provide investors with ideas across the investment spectrum. From there, they should start their own due diligence from ideas that seem interesting AND fit into their pre-defined investment philosophy and goals, which differ for each of us and will change as we age and our net worth changes.
