Sometimes the different variables associated with emerging market investing result in broadly distinct investor outcomes. Differentials such as currency and country allocation lead to a wide distribution in returns when we compare funds in the category
The below chart looks at the entire category of actively managed Emerging Market equity managers and shows their excess performance over time against a simple market cap-weighted index. Highlighting certain percentiles shows just how large this spread can be, with the huge disparity between winners and losers becoming particularly evident during periods of pronounced market volatility.
As an alternative, trackers funds using a simple market-cap weighted approach offer investors a more predictable and consistent allocation. As well as being relatively attractive on price, a good ETF will carefully balance between minimising concentration risk while remaining broadly representative of the countries that constitute merging equity markets.
Balancing out the China Allocation
Active managers have responded differently to China’s equity market growth and its increasing inclusion in major EM benchmarks. In a similar vein as above, the following chart breaks active managers down into percentiles and shows the average equity allocations to China. The majority of active managers continue to shy away from China-equity allocation by percentile, with only a quarter overweighting China.
Funds that under-allocate to China take on proportionate levels of active risk – by underweighting, they have a greater chance of missing out when markets rally. Active managers with under-allocations normally cite a wish to negate away some of the risk associated with such a large allocation to volatile Chinese markets, but multiple market cycles have shown that EM economies dependent on commodity exports have been amongst the most volatile allocations.
Sensible Portfolio Construction
Passive equity trackers straddle the line between what is a fair representation of EM equity countries and maintaining sound portfolio construction rules. Good ETF portfolios will:
- Keep turnover low
- Keep the China allocation between 35-45% of the overall allocation
- Maintain a sensible top 10 allocation without a handful of stocks dominating the portfolio
- Be priced competitively
With that said, below are four ETF picks for investors looking to for exposure to the region:
iShares Edge MSCI Emerging Markets Minimum Volatility ETF
This Silver-Rated ETF offers an optimised portfolio of EM stocks that have been selected to deliver the lowest possible variance of returns. Strategy-wise, the fund leverages a portfolio optimiser to select stocks from the parent universe, the MSCI EM Index, that create the optimal minimum volatility portfolio. In doing so, the fund aims to make a smoother ride of emerging markets by lowering volatility and improving downside risk.
Amundi IS MSCI Emerging Markets ETF
This Bronze-Rated Amundi fund is perfect for investors looking for a straightforward MSCI EM Index tracker. The fund uses synthetic replication to track performance and comes in at an attractive price, particularly against active peers who typically charge between 0.75-1.50% in management fees.
iShares Core MSCI EM IMI ETF
At a low fee, this Bronze-Rated ETF is an attractive option for investors seeking an all-cap emerging markets equity exposure. For the most part, the portfolio is very similar to an MSCI EM Index tracker but with a longer tail of around 1,500 small-cap stocks. As well as gaining this small-cap exposure, investors receive a softened exposure to China with an underweight of nearly 5% relative to its parent benchmark.
UBS MSCI EM SRI ETF
Investors seeking a socially-conscious allocation may find this Bronze-Rated ETF a better pick. It offers a screened portfolio of emerging market stocks from the wider MSCI Emerging Markets universe and is designed to exclude laggards on several ESG metrics such as carbon emissions and controversial weapons while using a best-in-class ESG selection approach. A 5% single issue cap keeps stock weights in check, helping to negate single stock concentration risk.
