A Better Way To Consider Emerging Markets With A WisdomTree ETF

Emerging markets equities and exchange traded funds are following U.S. equities lower. If and when that situation is rectified, investors looking to play an emerging markets rebound may want to consider going beyond traditional ETFs.

The WisdomTree Emerging Markets ex-State-Owned Enterprises Fund XSOE fulfills that objective. While old guard emerging markets benchmarks have evolved to feature more technology stocks, those indexes still feature substantial exposure to slow-growing, state-owned energy and financial services companies, among others. That strategy, which XSOE eschews, can sap investors' returns.

Government control is typically defined as more than 20 percent. XSOE follows the WisdomTree Emerging Markets ex-State-Owned Enterprises Index, which excludes companies controlled by emerging markets governments. That index had 666 components as of March 23. 

Dominating The Old Guard

Last year, XSOE outperformed the MSCI Emerging Markets Index in an impressive fashion, topping the emerging markets benchmarks by about 1,000 basis points.

“WisdomTree defines a SOE as a company where governments control at least 20 percent of the outstanding shares,” said WisdomTree in a recent note. “In October, that represented some 300 emerging market companies with a combined market value of approximately $2 trillion. Much of that value is concentrated in the Chinese banking and Russian energy sectors, although SOEs can be found in most developing nations. WisdomTree estimates that about 25 percent to 35 percent of the market capitalization of broad emerging market indexes are typically made up of state-owned entities.”

XSOE features exposure to 20 countries, but China, South Korea and Taiwan combine for about 58 percent of the ETF's geographic exposure. The fund allocates 33.21 percent of its weight to technology stocks, an overweight of more than 500 basis points relative to the MSCI benchmark. XSOE's consumer discretionary weight is more than 300 basis points higher than the MSCI index's.

State-Owned Risks

State-controlled companies carry risks that are not found with traditional companies, risks that XSOE works to prevent investors from incurring.

“Managing an enterprise well is a far greater challenge when executives are asked to serve two masters: private shareholders and government stakeholders,” said WisdomTree. “SOEs not only need to maximize shareholder value, they may also need to be mindful of public interests, as defined by politicians and bureaucrats. Sometimes those two imperatives conflict — and this may, over time, lead to suboptimal investment results for investors.”

Companies such as Alibaba Group Holding Ltd. BABA and Baidu.com Inc. BIDU, both XSOE top 10 holdings, do not present SOE risk to investors.

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