Tuesday, 15 December 2009

Emerging Market ETFs Compared - US-Traded ETFs

What are Emerging Markets?
Emerging Markets (EM) are those countries with less advanced economies, the lower half of the world per capita income spectrum. Led by the big four, so-called BRIC countries, of Brazil, India, China and Russia, the list also includes South Korea, South Africa, Argentina, Chile, Czech Republic, Egypt, Hungary, Indonesia, Israel, Malaysia, Mexico, Pakistan, Poland, Taiwan, Thailand, and Turkey.

There are several providers used by the various ETFs to construct an index to represent the countries and the companies to include, just as the S&P TSX Composite is used to benchmark the Canadian equity market.

  • S&P Emerging BMI Index - 21 countries, excludes South Korea (considered developed); 2252 stocks; goes down to the smallest and least liquid companies of the three indices

Why Emerging Markets?
Growth: Emerging Markets countries are harder and harder for the Canadian investor to ignore. In July Bloomberg reported that Emerging countries now constitute 24% of world equity market capitalization, up from 18% from only the start of the year. EM stock markets have bounced back much more strongly from the 2008 crash during 2009 than any of Canada, the USA or Europe.
Diversification: Not only have such countries offered faster economic growth and stock appreciation than developed countries, they offer Canadian investors companies in sectors weakly represented in Canada's TSX equity index, such as information technology, health care, industrials and utilities. As a result of the different industry structure, economic policies and exchange rate fluctuations, the equity returns from these countries do not move in perfect lockstep with Canadian or US returns, allowing an investor to construct a more stable portfolio by including such holdings.
Risks: EM countries are less stable economically, less well regulated financially and more prone to corruption and other problems that make stock investing riskier. The swings of their stock markets, individually and even as an group, have been much more pronounced, which is the prime reason to reduce risk through an ETF with many company and country holdings and to not go overboard as a proportion of portfolio.

ETFs Traded on US Markets
The largest and best established ETFs available to Canadian investors are traded on US markets. Though that means they are denominated in US dollars (USD), the real currency exposure is, since none are hedged against currency shifts, to the combination of all the EM countries, not the USD (see CanadianFinancialDIY's explanation). The list below includes only broad market ETFs. There are many others available, ranging from individual country funds, to groups of countries (e.g. BRIC), to leveraged bull and bear funds - see the Stock-Encylcopedia's Emerging Markets list.

  • Vanguard Emerging Markets ETF (symbol: VWO) - massive fund with lowest expense ratio and broadest actual diversification - most companies held, least concentration by country
  • iShares MSCI Emerging Markets Index Fund (EEM) - the big daddy fund, largest and most liquid; high expense ratio but has done best job tracking its chosen index, the MSCI and has out-performed VWO, which tracks the same index, by a cumulative 8% since 2005, as this Google Finance chart shows
  • Powershares FTSE RAFI Emerging Markets Portfolio (PXH) - unique strategy selects holdings based on accounting value factors; highest expense ratio of the lot but has outperformed all the others by a bit since its founding in 2007 (see chart below)
  • BLDRS Emerging Markets ADR 50 Index Fund (ADRE) - focused on a few large companies and thus least diversified, but its ADR holdings get the benefit of being obliged to meet higher accounting and reporting hurdles; has performed better than both VWO and EEM since 2005
  • SPDR S&P Emerging Markets ETF (GMM) - quite new with 2007 start-up, having trouble tracking its index and trading at a very high discount to NAV of 1.4% as of 31 Oct 2009; lots of holdings, not concentrated but excludes Korea
Comparison Table

That's already a good selection of Emerging Market ETFs for the Canadian investor to choose from. The next post will review the Canadian-traded ETFs.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation and that past performance may not continue, costs may change and other comparative factors like taxes may alter their value to you. Do your homework before making any decisions.

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