But the benefit of active management in emerging countries is much more muted in the latest SPIVA Scorecard, an annual publication from S&P Dow Jones Indices. About 12% of U.S. large-cap funds outperformed the S&P 500 over the five-year period ending December 31, 2016, while 25% of emerging market funds outperformed their benchmark indices over the same period. Sixteen percent of actively managed emerging market funds outperformed over three years, versus 7% for large-cap U.S. funds.
Jean Van de Walle, the chief investment officer at Sycamore Capital in Madison, N.J., suggested in a blog that the wide discrepancy between the two studies may be at least partially due to the better performance of the emerging market index used by S&P than the composite results of emerging market ETFs used by Morningstar. He also noted that emerging market active managers may have benefited from the bear market by holding some cash, even though that would harm returns in a bull market. “Furthermore, assuming positive performance for EM equities, indexed products are likely to be more formidable competitors in coming years, as they tend to outperform in bull markets.”
Those going the ETF route can choose from 195 different emerging markets ETFs with over $200 billion in assets. Most investor money has been directed to the three big diversified, market-cap-weighted players that dominate the market.
The largest player in the group is the $63 billion Vanguard FTSE Emerging Markets ETF (VWO). The third-largest ETF in Vanguard’s stable, it follows a market-cap-weighted index of 21 emerging markets and excludes South Korea, a country that makes up about 15% of the MSCI Emerging Markets Index. The VWO fund has an expense ratio of 0.14%.
The iShares Core MSCI Emerging Markets fund (IEMG) has $37 billion in assets and an expense ratio of 0.14%. It does include South Korea, as does the iShares MSCI Emerging Markets fund (EEM), which has $36 billion in assets. The EEM fund, one of the older members of the group, is very similar to the IEMG fund except that it has more large capitalization stocks and a much higher expense ratio (0.69%). The EEM fund also has five times the average daily trading volume of IEMG and a much larger options market, making it the more popular choice for traders.
A smaller diversified offering, the $4.3 billion Schwab Emerging Markets Equity fund (SCHE), offers a worthy alternative to the giants in the space. Its expense ratio is only 0.13%. And like the Vanguard fund, it has no exposure to South Korea.
All these market-cap-weighted ETFs have a hefty allocation to China ranging from 26% to almost 30%.
Factor ETFs are also a growing slice of this segment. Because of their index construction, many have country weightings, stock holdings and performance that differ significantly from those attributes in the more popular traditional market-cap-weighted benchmarks.
For instance, the $4 billion iShares Edge MSCI Minimum Volatility Emerging Markets fund (EEMV) consists of stocks from the MSCI Emerging Markets Index that have enjoyed a history of low volatility. The fund, which has an expense ratio of 0.25%, has less in basic materials and energy than the MSCI index, and more in health care.
The $1.6 billion Schwab Fundamental Emerging Markets Large Company multi-factor fund (FNDE) selects stocks for its index based on the companies’ sales, cash flow and dividends. It has a lower allocation to China than the major market-cap-weighted funds and more to South Korea. Its expense ratio is 0.40%.