For many investors, emerging-market ETFs have evolved from an exotic investment offshoot to a portfolio staple. In 2011, Vanguard's MSCI Emerging Markets ETF (VWO), the largest of the group, had the heftiest inflows of any exchange-traded fund-an especially notable milestone given that its net asset value plunged nearly 19% that year. That ETF and another following the same index, the iShares MSCI Emerging Markets Index Fund (EEM), now hold a total of $80 billion in assets.
These two powerhouses have plenty of likable qualities. Their low cost, liquidity and convenience have opened the doors of growing markets such as China, Brazil and India to thousands of investors, who hope these countries have stronger economic growth than the U.S. and other developed nations and thus offer higher long-term stock market returns.
But investors in these funds are also concentrated in a handful of countries, and that limits their diversification benefits. The iShares offering, for example, has 58% of its assets in China, Brazil, South Korea and Taiwan. (By some measures, the latter two countries are rapidly becoming developed markets.) South Africa, India and Russia account for another 21% of assets.
"That leaves roughly 20% of the rest of the emerging world," says Zacks Research ETF strategist Eric Dutram. "Most investors are heavily concentrated in a few countries and could stand to look at some national ETFs to round out their emerging markets exposure." Other investors might benefit by augmenting the "Big Two" emerging market ETFs with single-country or regional ETFs to get more exposure to areas they believe will outperform other global markets.
The list of ETFs that can accomplish these goals is as vast and wide-ranging as the countries they represent. The database at Indexuniverse.com shows 108 emerging-market offerings focusing on specific countries or regions-or even on specific stock market capitalizations or market sectors within those regions. The single-country ETFs can focus on established markets such as Brazil and China or far-flung countries such as Vietnam and Poland. Among the biggest winners so far this year are iShares' MSCI Brazil fund (EWZ) and WisdomTree's India Earnings ETF (EPI). The former was up 15.63% in January alone, while the latter rose 23.59% for the month.
The values of these focused ETFs, however, often careen around more than the already-volatile broader emerging market indices. For example, the WisdomTree offering's snapback in early 2012 was preceded by a decline in 2011 of more than 40%, about double the slide for the broader emerging market indexes. Other India-focused ETFs fell by a similar amount.
Despite such volatility, proponents say advisors could benefit by augmenting broad-market emerging market exposure with more narrowly focused bets.
"The problem with the large, broad-based emerging market ETFs is that they focus on large-cap companies that rely on exports for most of their revenue," says Adam Patti, chief executive officer of IndexIQ, which specializes in indexed-based investments. "So even though those companies are based in emerging-market countries, they are not pure emerging-market plays. And their businesses are vulnerable to developed-market economic cycles."
He also notes that the popularity of the two largest emerging-market ETFs has made emerging-market large caps less attractively valued than those in the small and mid-cap space and reduced their dividend yields. "There is a lot of money chasing those two ETFs around, and that is bound to have impact," he says.
Patti says the IQ Emerging Markets Mid-Cap ETF (EMER) addresses those issues by tracking midsize companies, which derive most of their revenues from their home countries. Because they are less well-followed by analysts than large caps, he says, they also have more reasonable valuations. The IQ South Korea Small Cap ETF (SKOR) gives investors exposure to that country's economy beyond large exporters such as Samsung.