Many investors consider emerging markets an unstable and unknown place to invest, but some investment professionals believe developing countries are a critical part of any globally balanced portfolio.
“Global diversification is instrumental to any sensible asset allocation strategy and emerging markets have a place in that,” says Benjamin Felix, a portfolio manager at PWL Capital Inc. in Ottawa.
Investors who shy away from emerging markets equities are “missing out on the sources of expected returns all around the world,” Mr. Felix says. “That’s a very easy risk to take away just by diversifying.”
Emerging markets can experience the fastest growth but can also be volatile. The MSCI Emerging Markets Index, used to measure equity market performance across more than two dozen emerging market countries such as China, Taiwan, India and Brazil, has been rising steadily since its sharp decline in mid-March and following volatile performance through 2019 and early 2020.
We asked three experts for their top picks for emerging market ETFs.
Benjamin Felix, a portfolio manager at PWL Capital Inc. in Ottawa
Management expense ratio (MER): 0.27 per cent
Assets under management (AUM): $723.2-million
Year-to-date (YTD) gain: 1.0 per cent
One-year gain: 6.9 per cent (All data from Morningstar as of market close July 20).
This ETF holds almost 2,500 stocks including such top holdings as Alibaba Group Holding Ltd., Tencent Holdings Ltd., Taiwan Semiconductor Manufacturing Co. Ltd. and Samsung Electronics Co. Ltd. These technology stocks are at the top of most emerging market ETFs, but in varying percentages.
The top sector in XEC is financials at 18 per cent, followed by information technology at 17.6 per cent and consumer discretionary rounding out the top three at 15.4 per cent. Geographically, the top three countries are China at about 38 per cent, Taiwan at 13 per cent and South Korea and 12 per cent.
“It’s nothing special, it’s a market capitalization-weighted emerging markets ETF, but it’s low cost and it’s well-diversified,” Mr. Felix says. “It’s a bread-and-butter pick in any model portfolio.”
MER: 0.33 per cent
YTD loss: 6.3 per cent
Gain since its inception in Sept. 2019: 4.2 per cent
U.S.-listed AVEM is similar to XEC in terms of being low cost and well-diversified, Mr. Felix says. It holds about 2,500 stocks including some of the same big names as XEC including Tencent, Taiwan Semiconductor, Alibaba, Samsung and the H shares of China Construction Bank Corp., which trade in Hong Kong. But AVEM holds those stocks at about half the weighting of XEC, making its weightings on the smaller stocks larger overall.
“The big difference with AVEM is that the portfolio is tilted toward smaller companies and less expensive companies — so more value-oriented companies within emerging markets,” Mr. Felix says. “Emerging markets are already cheap in terms of their price so with AVEM you’re getting even cheaper emerging markets securities. You would want to do that because smaller and cheaper companies have higher expected returns than the market as a whole.”
Alan Fustey, portfolio manager with Adaptive ETF in Winnipeg, a division of Bellwether Investment Management Inc.
MER: 0.10 per cent
YTD loss: 2.5 per cent
1-year gain: 4.1 per cent
The ETF, which holds more than 5,000 stocks, aims to track the performance of the FTSE Emerging Markets All Cap China A Inclusion Index and focuses on stocks in that index, which includes large-, mid- and small-cap names.
“It invests in emerging markets around the world including Brazil, Taiwan, South Africa but it also includes China and, for us, that is something we want in the portfolio,” Mr. Fustey says.
“Chinese markets have actually done fairly well this year versus world markets,” he says, noting they have bounced back after the first wave of COVID-19. China also put in place strong stimulus programs and central bank support.
Another key factor is that Vanguard is a well-known ETF provider, the MER is low, and the fund has strong liquidity, which helps with large trades, Mr. Fustey says.
MER: 0.27 per cent
YTD gain: 1.8 per cent
1-year gain: 8.9 per cent
“ZEM is also a broad-based, multi-country emerging market ETF,” Mr. Fustey says, and it holds about 850 stocks. “It tracks a different index than the VWO, but both ETFs include China in their portfolios.”
The fund aims to replicate the performance of the MSCI Emerging Markets Index and holds equities and other ETFs. The top countries it invests in include China, Taiwan, South Korea and Brazil.
ZEM is traded on the TSX and is priced in Canadian dollars, while VWO trades in the U.S. and is priced in U.S. dollars. “Therefore, the two securities may appeal to investors who have a preference in which currency they choose for their portfolio assets,” Mr. Fustey says.
David Kletz, vice-president and portfolio manager, Forstrong Global Asset Management
MER: 0.49 per cent
YTD gain: 5.6 per cent
1-year gain: 13.4 per cent
GMF holds about 1,300 stocks and aims to match the S&P Asia Pacific Emerging BMI Index, a market capitalization-weighted index that measures publicly traded companies in emerging Asia-Pacific markets.
Mr. Kletz likes this ETF because of its narrow focus on the Asia-Pacific region. “From a quality perspective, Asia does tend to have a healthier fiscal situation, a healthier government balance sheet,” he says.
Many countries, including South Korea, Taiwan and China were able to effectively manage the COVID-19 pandemic without having to “empty” their fiscal coffers, he says, which will likely benefit them in the future. They’ve also been able to restart their economies quickly, giving them a “first-mover advantage.”
Asia, including India and southeast Asia, also has a burgeoning middle class and “that’s a massive tailwind; having a growing domestic market,” Mr. Kletz says. “It makes the Asian region, in general, less dependent on global growth.”
MER: 0.60 per cent
YTD gain: 15.2 per cent
1-year gain: 25.8 per cent
KEMQ helps investors diversify in emerging markets and adds technology exposure, including stocks such as Tencent, Naver Corp. and Alibaba, Mr. Kletz says. Many broad, emerging market ETFs hold a significant weight of about 20 per cent in financial stocks, which he says can be under the same pressures as Canadian banks — a staple in many Canadian investor portfolios.
“It does make sense to be a bit more targeted and try to diversify your portfolio a little bit further,” Mr. Kletz says.