Low Vol Emerging Markets ETF Has Perks And Drawbacks

Earlier this year, the low volatility factor was the object of much attention and adulation, and that affection was not limited to U.S.-focused exchange-traded funds.

iShares EEMV

The iShares Edge MSCI Min Vol Emerging Markets ETF, iShares Inc. EEMV also caught investors' attention, as many looked to lower risk alternatives to get involved with emerging markets equities as the asset class rebounds following several years of lackluster returns.

As is the case with U.S.-focused low volatility ETFs, it is reasonable to expect an international equivalent, such as EEMV, to lag traditional funds when the target asset class is overtly rallying. And that is what emerging markets stocks are doing this year. Likewise, it should be expected that when emerging markets stocks slump, EEMV will perform less poorly, which the fund did last year.

Mitigating Volatility

EEMV, “which offers exposure to these historically volatile stocks while mitigating the magnitude of the ups and downs, might be worth considering for those who want to tap into these markets without getting whipsawed,” said Morningstar in a recent note. “In fact, since EEMV’s inception in October 2011 through October 2016, it has outperformed the MSCI Emerging Markets Index by 2.26 percentage points, annualized. Over the same period, EEMV had nearly 25 percent less volatility relative to the market-cap-weighted MSCI Emerging Markets Index.”

However, the low volatility rub is being epitomized by EEMV this year. With emerging markets stocks rebounding, EEMV is higher by just 4.2 percent, less than half the 10.4 percent gained by the MSCI Emerging Markets Index year-to-date. EEMV has been nearly 600 basis points less volatile than the traditional emerging markets benchmark.

Exposures

Explaining EEMV's laggard status is not difficult. As a low volatility emerging markets ETF, EEMV allocates barely more than 2 percent of its combined weight to Brazil and Russia, two of the most volatile developing economies. However, those are two of this year's best-performing emerging markets.

Overall, EEMV's Latin America exposure is just about 9 percent, a disadvantage at a time when that region is lifting emerging markets benchmarks higher.

EEMV's Strategy

“EEMV uses an optimizer to construct the least volatile portfolio possible using constituents of the MSCI Emerging Markets Index, under a set of constraints. The optimizer considers each stock’s volatility in addition to how the correlation between stocks affects the portfolio’s volatility. It uses this information to select and weight stocks from the parent index,” added Morningstar.

To be fair, EEMV outperformed the MSCI Emerging Markets Index 230 basis points over the past three years, a mostly rough period for emerging equities.