How to choose the right emerging-market ETF

15-Nov-2013

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An eternal optimist, Liu-Yue built two social enterprises to help make the world a better place. Liu-Yue co-founded Oxstones Investment Club a searchable content platform and business tools for knowledge sharing and financial education. Oxstones.com also provides investors with direct access to U.S. commercial real estate opportunities and other alternative investments. In addition, Liu-Yue also co-founded Cute Brands a cause-oriented character brand management and brand licensing company that creates social awareness on global issues and societal challenges through character creations. Prior to his entrepreneurial endeavors, Liu-Yue worked as an Executive Associate at M&T Bank in the Structured Real Estate Finance Group where he worked with senior management on multiple bank-wide risk management projects. He also had a dual role as a commercial banker advising UHNWIs and family offices on investments, credit, and banking needs while focused on residential CRE, infrastructure development, and affordable housing projects. Prior to M&T, he held a number of positions in Latin American equities and bonds investment groups at SBC Warburg Dillon Read (Swiss Bank), OFFITBANK (the wealth management division of Wachovia Bank), and in small cap equities at Steinberg Priest Capital Management (family office). Liu-Yue has an MBA specializing in investment management and strategy from Georgetown University and a Bachelor of Science in Finance and Marketing from Stern School of Business at NYU. He also completed graduate studies in international management at the University of Oxford, Trinity College.

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By Charles Sizemore, MarketWatch,

It’s been a rotten year for emerging markets. The iShares MSCI Emerging Markets ETF (EEM) — one of the most popular ways for investors to play the sector — is down 13% year to date. And several individual country funds have gotten hit a lot harder. The iShares MSCI Brazil ETF (EWZ) is down 23% year to date, and the iShares MSCI Turkey ETF (TUR) is down a whopping 26%.

Ouch.

A slowdown in China, a political crisis in Turkey, and the Fed’s “taper scare” combined to mix a lethal cocktail for the sector. But now that the dust has settled, are emerging markets a buy?

I believe, yes. With American stocks looking close to fully valued, investors are shifting their attention to developed Europe, where valuations are nearly 40% lower. And as risk appetites return, I expect them to turn to emerging markets next, where pricing appears even better. As measured by their price/book ratios, emerging markets as a group trade for less than half their pre-2007 valuations.

The question is not whether to buy emerging markets but how. As a general rule, I’ve avoided the iShares MSCI Emerging Market ETF because I consider it far too heavily weighted to developed markets such as South Korea and Taiwan and to companies that get a large chunk of their revenue from exporting to America and Europe. Its underlying index recently started to include Greece.

Yes, Greece. While I agree that Greece shouldn’t be classified as a developed market, I don’t see a lot of “emerging” going on there.

I think that other broad ETFs give better access to the emerging market consumer. One that I use in my asset allocation portfolios is the Emerging Global Shares Emerging Market Consumer ETF (ECON). The underlying companies get about 90% of their revenue from selling within their home markets and to other emerging markets.

I continue to like ECON as a long-term holding in my portoflios. But there are other ways to slice and dice the emerging markets universe, such as by dividend yield. James P. O’Shaughnessy, the author of What Works on Wall Street, wrote a paper earlier this year that found that a strategy of buying high-dividend, emerging-market stocks outperformed the broader emerging market universe by 10.6% per year. Yes, you read that correctly.

If you’re looking for an ETF solution, Emerging Global Shares offers one: the EG Shares EM Dividend High Income ETF (EMHD). The portfolio has an eclectic mix of emerging-market stocks you’re not likely to find anywhere else, such as Bangkok Expressway, Telecom Egypt, and Ford Otomotiv Sanayi, Turkey’s local Ford subsidiary.

In total, it holds the 50 highest-yielding stocks in the FTSE Emerging All Cap ex-Taiwan universe, equally weighted, and is expected to sport a dividend yield around 8% (the shares only recently started trading, so there is no actual dividend history as of this writing). As attractive as EMHD is as a portfolio diversifier, it’s too thinly traded to buy at this time. Its average daily trading volume is a tiny 4,350 shares.

A more liquid option is the WisdomTree Emerging Markets Equity ETF (DEM). DEM is based on a fundamentally weighted index that is comprised of the highest-dividend-yielding stocks selected from the WisdomTree Emerging Markets Dividend Index. At current prices, DEM yields 5.9% in dividends.

DEM is a little too heavily allocated to basic materials for my liking, and its top two holdings — which collectively make up more than 10% of the portfolio — are Russian oil and gas companies. Still, if nothing else, DEM offers a way to get non-traditional exposure to emerging markets and access to companies you’re not going to get in the more popular emerging market funds.

This commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.

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