Get True Emerging Market Exposure With These Three ETFs (EEM, VWO, HILO, BKF, AGEM)

Eric Dutram: Sometimes, the line between developed and emerging markets is razor thin. This has especially been the case for two of Asia’s largest economies; Taiwan and South Korea.

These two nations represent some of the most robust economies in the region both from a total level and a per capita reading, but are often classified as ‘emerging’ by some of the major index firms. In particular, the indexing giant MSCI still classifies them as developing countries although other benchmark providers, such as Dow Jones, have moved these nations into the developed market club.

Some had hoped that MSCI would finally move up the two nations into developed market status at its annual review of country classifications, but both remained firmly in the emerging market camp according to the index provider. This forces these two countries to stay in the emerging market realm for another year, hoping that the company will come around on these two nations in 2013.

This annual rejection continues to surprise some in the industry as South Korea and Taiwan both have large markets that are much more diverse than many of their small peers that are already classified as industrialized nations (see Three Overlooked Emerging Market ETFs).

In fact, both of the nations have, according to the IMF, a higher GDP per capita (PPP) than the EU average, while both have exceptionally high rates of economic freedom and competitiveness that put many other ‘industrialized’ members to shame.

Why It Matters For ETF Investors

While this problem may not seem very important to most investors on the surface, it actually has a huge implication for emerging market ETF investors. Thanks to MSCI’s refusal to put either of the countries in the developed market indexes, they have grown to make up an outsized percentage of some of America’s most popular emerging market ETFs.

This includes two of the top ETFs on the market today both of which track the MSCI Emerging Markets Index. These two funds, the Vanguard MSCI Emerging Markets ETF (NYSEARCA:VWO) and theiShares MSCI Emerging Markets Index Fund (NYSEARCA:EEM) account for nearly $85 billion in AUM as well as the lion share of assets in the developing market ETF world (see Seven Biggest International Equity ETFs).

However, both of the funds, since they follow the MSCI methodology, have close to one-fourth of their assets in the combination of Taiwan and South Korea. This suggests that the products may not offer the ‘truest’ emerging market exposure and instead have a great deal of assets in companies from countries that are arguably developed and not emerging.

Ways To Avoid

Luckily for investors, there are a number of ways to avoid this issue thanks to the proliferation of emerging market ETFs. No more does the space consist of just MSCI based products giving investors a choice among over 50 ETFs that have assets exclusively in emerging nations (see more in the Zacks ETF Center).

Below, we highlight three of our favorite emerging market ETFs which offer no exposure to either Taiwan or South Korea. While both of these markets could make for fine investments, we don’t believe that they should be treated as emerging by any means, suggesting that for better emerging market ETF exposure, the following ETFs should be considered instead:

EGShares Low Volatility Emerging Markets Dividend ETF (NYSEARCA:HILO)

This product tracks the Indxx Emerging Market High Income Low Beta Index which is a dividend yield weighted benchmark that looks to provide investors with a higher payout and less volatility than the aforementioned MSCI Emerging Market Index. Currently the product has 30 securities in its basket, pays out a dividend of about 6.4%, but sees fees of around 85 basis points per annum.

In terms of country exposure, Thailand takes the top spot at 16.9% of assets but it is closely trailed by Chinese and Brazilian securities as well. Beyond these nations, South Africa, Hungary, and Malaysia round out the top six countries represented (see Frontier Market ETF Investing 101).

Given the focus on high dividends and low volatility, investors shouldn’t be surprised to note that telecom (33%) and utilities (17%) constitute the majority of the assets. Beyond these two segments, cyclical consumer stocks, along with industrials and consumer staples, complete the top five leaving just under 25% for financials, energy, tech, and basic materials.


For a BRIC-focused alternative, investors have a couple of choices. We like BKF for its relative balance among the four nations of Brazil, Russia, India, and China, especially when compared to some of its peers. The product also holds an impressive number of securities at over 300, while charging investors a reasonable 67 basis points a year in fees.

BKF puts 40% of its assets in China, 30% in Brazil, and then roughly the rest in equal amounts between India and Russia. The product’s yield isn’t too impressive at just over 1.1% in 30 Day SEC Yield terms, but it does a great job of spreading assets around putting just 27.5% of assets in the top ten holdings (see Top Three BRIC ETFs).

From a sector perspective, financials and energy account for roughly 50% of assets, while basic materials is the only other segment to make up more than 10% of the total. Large caps also dominate the exposure profile, although it should be noted that there is a definite tilt towards growth firms as well.


For a broad play on the emerging market space without the influence of South Korea or Taiwan, AGEM presents a compelling choice by tracking the Dow Jones Emerging Markets Sector Titans Composite 100 Index. This benchmark, as the name suggests, holds 100 stocks in its basket and provides broad exposure across a variety of market segments in numerous nations around the globe.

The ETF charges investors 75 basis points in fees for its services but hasn’t really caught on with investors so far. The average volume is still below 10,000 shares a day suggesting that bid ask spreads could be relatively wide in this fund (read Go Local With Emerging Market Bond ETFs).

Still, it represents a solid pick for long term investors as it has a well diversified portfolio that doesn’t put more than 5% in any one security. Sector exposure, however, is tilted towards energy and financials, although telecom and consumer staples both account for double digit allocations as well.

For countries, China takes the top spot at just over 27% of the total, followed by a 16% allocation to Russia and a 14% holding in Brazilian firms. The next three markets are South Africa, India, and Mexico, suggesting that the product also has a nice mix among the various emerging regions of the world.

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Written By Eric Dutram From Zacks Investment Research  Author is long VWO.

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.


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