Inside A Multifactor Emerging Market ETF


Emerging market ETFs are picking up steam again. Many market outlooks coming into 2019 called for better days in emerging markets, and in January, the iShares Core MSCI Emerging Markets ETF (IEMG) was the most popular ETF.

IEMG raked in $4.23 billion in fresh net assets during a month when investors yanked $25.5 billion from U.S. equity ETFs.

It’s easy to see why. If the goal is to access emerging market stocks, IEMG is big, cheap, liquid and hugely popular.

It’s a market-capitalization-weighted total market ETF that invests in more than 2,200 emerging market stocks for a 0.14% expense ratio—$14 per $10,000 invested. With this fund, you get comprehensive exposure that’s diverse across countries and segments without making any specific bets. IEMG captures MSCI’s view of the emerging market universe.

Bigger Not Always Best-Performing

All these traits, however, don’t necessarily equate with best-in-class performance. In reality, when it comes to emerging market ETFs—or any segment, for that matter—there are many different approaches to slicing and dicing the space, from different weighting schemes, to sector bets, to factor picking, to options overlays, and so on. With every tilt comes a different return stream.

Consider, for example, how a multifactor portfolio of emerging market stocks—also offered by iShares—stacks up relative to the vanilla IEMG—the iShares Edge MSCI Multifactor Emerging Markets ETF (EMGF), which launched in 2015.

EMGF fishes in the same MSCI universe, but picks and weights emerging market stocks deliberately to increase exposure to four factors—quality, value, momentum and small size. While the fund strives to keep region and sector allocations somewhat in line with the market-cap-weighted MSCI Emerging Markets Index, the strategy is designed to capture outperformance.

How does a multifactor approach such as EMGF compare to a market-cap one such as IEMG? In 2018, it didn’t do so well, underperforming market-neutral by 5 percentage points in a year when emerging market ETFs in general fared poorly, as the chart below shows. In this case, the smart-beta portfolio didn’t offer any cushion on the downside last year.

 

 

However, so far in 2019, we are seeing a reversal in leadership between the two funds, both of which are up this year. EMGF is ahead:

 

Charts courtesy of StockCharts.com

 

From a country and sector allocation perspective, there are some differences in these portfolios. For example:

  • China: EMGF allocates almost 32% to China vs. 28% for IEMG
  • India: IEMG has double the weighting to India that EMGF has
  • Consumer Sectors: EMGF goes more heavily into consumer discretionary stocks, but it is notably underweight consumer staples relative to IEMG

And the list goes on. Using ETFs for proxies of market performance, consider that in 2018, Chinese equities were hit hard, with mainland stocks down some 28%, and Hong Kong-listed equities down about 13% (you can look at the performance of the Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR) and the iShares China Large-Cap ETF (FXI)).

China, which was much more of a drag on portfolio returns last year, carries more weight in EMGF. India (as measured by the iShares MSCI India ETF (INDA)) was down a far more modest 6.6% last year.



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