2 Emerging Markets ETF Myths Demystified

Select, and that word should be emphasized, emerging markets ETFs have not impressed since the start of the year. The two biggest members of this asset class as measured by assets under management, the Vanguard FTSE Emerging Markets ETF VWO and the iShares MSCI Emerging Markets Index Fund EEM are of 1.18 and 1.35 percent, respectively. Some country-specific funds have been worse. Actually, some have been downright dreadful and can easily be placed in the falling knife category. In other words, there is no denying that when an investor takes a broad view of things, emerging markets ETFs probably are not the most attractive funds to get involved with at the moment. EEM and VWO seem to affirm that assertion, but speaking of emerging markets ETF in generalities is not always the most accurate way of approaching the subject. Arguably, it creates a situation where some prevalent myths need to be busted, starting with... Correlations to U.S. Stocks Conventional wisdom holds that emerging markets equities are a volatile asset class that can serve as useful gauge of investors' willingness to embrace riskier fare. From there, some might assume that if emerging markets are not in favor, then riskier assets such as equities are generally not in favor. The next logical step under this scenario is assuming U.S. equities might be in for a pullback due to the slack performances of their emerging markets peers. Not so fast. Over the past three years, EEM has a correlation of just 0.24 to the SPDR S&P 500 SPY while VWO's three-year correlation to SPY is just 0.22, according to State Street data. The chasm between U.S. stocks and this pair of diversified emerging markets ETFs appears to be widening. Over the past year, SPY has jumped 12.7 percent while EEM and VWO are each down about two percent. Year-to-date, EEM and VWO are both down more than one percent while SPY is up 8.7 percent. Those statistics confirm that even while investors pull money from some emerging markets ETFs, they are not eschewing U.S. stocks to a similar degree. Not All Emerging Markets Have Been Bad The problem with highlighting the slack performances of ETFs such as EEM and VWO is that those conversations give off the impression that all emerging markets have recently been slack performers. In reality, that is not the case and investors need to examine which countries truly drive price action in diversified emerging markets ETF before believing all developing world stocks are laggards. Take EEM as an example. China, South Korea, Brazil and Taiwan combine for over 56 percent of that ETFs. Of the four largest ETFs tracking those countries, only the iShares MSCI Brazil Capped Index Fund EWZ is higher year to date and that ETF only moved into the green this week. Throw in the fact that South African Indian and Malaysian stocks have performed poorly and it is easy to see why diversified emerging markets ETFs have struggled. Those three countries combine for almost 17 percent of EEM's weight. Those statistics should not be ignored, but they do not mean all emerging markets have performed poorly this year. For example, focusing on two of 2012's leaders – the iShares MSCI Thailand Capped Investable Market Index Fund THD and the iShares MSCI Philippines Investable Market Index Fund EPHE – has proven efficacious. Those two ETFs are up an average of 14 percent year-to-date. Another example is the Market Vectors Indonesia ETF IDX, which has surged 12.4 percent year-to-date. Bottom line: Not all emerging markets have slumped this year. Implying that is the case simply by using broad ETFs as the guide is inaccurate. For more on ETFs, click here.