A Quality Perk With This ETF

Valuation is being widely cited as one of the primary catalysts behind the emerging markets resurgence this year, but some emerging markets exchange-traded funds offer advantages beyond holding stocks that are inexpensive relative to U.S. benchmarks.

The WisdomTree Emerging Markets ex-State-Owned Enterprises Fund XSOE is up 39.1 percent year to date, outpacing the widely followed MSCI Emerging Markets Index by about 1,000 basis points. Given its name, it is easy to assume the reason why the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund is outpacing traditional developing benchmarks this year is because the fund excludes state-run companies.

While that is part of the reason for XSOE's impressive performance, there are other reasons why this fund is one of this year's most impressive emerging markets ETFs.

A Quality Call

When it comes to emerging markets stocks, state-owned companies are often viewed as value plays given the high concentration of these companies in value sectors, such as energy and financial services. Companies that can be viewed as quality plays often dwell in other sectors in the developing world.

“What is interesting about these sector profiles is that they tilt toward higher 'quality' sectors and away from 'value' sectors,” said WisdomTree in a recent note. “This also can be observed by the difference in both return on equity (ROE) and return on assets (ROA) for companies that are/are not state owned.” 

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While XSOE does allocate 17.3 percent of its weight to the financial services sector, still below traditional emerging markets benchmarks, the ETF allocates over a third of its weight to technology stocks. Combined, the technology and consumer discretionary sectors, quality groups in the emerging world, are nearly 47 percent of the ETF's lineup.

Quality Matters

There are clear advantages XSOE's quality approach, including the tilt away from sectors that can potentially hinder the fund's performance.

“What’s most noticeable is the top ROE quartile (ROE > 18 percent): State-owned firms had dramatically less exposure in these most highly profitable firms,” said WisdomTree. “The highest ROA quartile encompasses firms with ROA above 8.5 percent. Non-state-owned firms had exposure to this quartile of about 40.5 percent — almost 4x the exposure of state-owned firms at 11.6 percent.”

Due to a lack of exposure to state-owned commodities producers, Brazil and Russia combine for just 9 percent of XSOE's geographic exposure. By virtue of the fund's emphasis on technology stocks, China, South Korea and Taiwan combine for over 56 percent of the ETF's weight.

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