This Emerging Markets ETF Can Deal With The Strong Dollar

Much has been made of the strong dollar's impact on emerging markets equities and the relevant exchange traded funds. Price action bears out that impact.

Over the past year, the Vanguard FTSE Emerging Markets ETF VWO and the iShares MSCI Emerging Markets ETF EEM, the two largest emerging markets ETFs by assets, are both down just over 15 percent while the PowerShares DB US Dollar Index Bullish Fund UUP, the U.S. Dollar Index tracking ETF, is higher by 10.2 percent.

The declines of EEM and VWO do not paint the entire picture of the repudiation suffered by emerging markets ETFs at the hands of the strong greenback. From Brazil to South Africa to Turkey, scores of emerging markets funds have been pummeled by the rising dollar and speculation that higher U.S. interest rates could stoke a raft of credit ratings downgrades throughout the developing world.

The WisdomTree Strong Dollar Emerging Markets Equity Fund EMSD, which debuted last week, could be the tonic for investors looking to stick developing world equities even as the dollar rises.

While some ETFs have attempted to isolate developed markets companies positioned to benefit from favorable emerging markets growth trends, the WisdomTree Strong Dollar Emerging Markets Equity Fund goes the other way. The new ETF follows the WisdomTree Strong Dollar Emerging Markets Equity Index (WTEMSD), a benchmark that includes emerging markets firms that depend on the U.S. for at least 15 percent of their revenue.

“Instead of utilizing a currency-hedged approach, the WisdomTree Strong Dollar Emerging Markets Equity Index seeks to mitigate the risk of a strengthening U.S. dollar through its stock selection and resulting country, sector and underlying currency exposures inherent to this approach,” said WisdomTree in a recent research note.

Since its 130 constituents are highly dependent on the U.S. for big chunks of their revenue, it is not surprising EMSD's two largest sector weights are 36 percent to technology and over 24 percent to consumer discretionary. As a result of that technology weight, which is truly substantial relative to other emerging markets ETFs, EMSD's two largest country weights are South Korea and Taiwan. Those low beta emerging markets combine for 72 percent of the new ETF's geographic weight.

Conversely, EMSD's exposure to some of the emerging markets with the worst-performing currencies is light.

“On the other hand, some of the worst-performing currencies over this period were the Russian ruble (down 19.9%), the Brazilian real (down 19.5%), the Malaysian ringgit (down 16.6%) and the South African rand (down 12.3%). These currencies comprised about 20% of the MSCI Emerging Markets Index, but they comprised only about 8.7% of the WisdomTree Strong Dollar Emerging Markets Equity Index,” according to WisdomTree.