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A Need-to-Know Emerging Markets ETF

August 14, 2013 1:22 pm
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A Need-to-Know Emerging Markets ETF

Emerging markets ETFs have languished through a dismal 2013, but some diversified funds have recently started to pick up the pace. Some decent Chinese data and an improving economic outlook for the Eurozone, a prime destination for emerging markets exports, have been among the catalysts lifting select emerging markets ETFs over the past month.

The emerging markets “rebound,” if it can yet be called that, is still in its nascent stages, but this is the ideal time for investors to begin identifying those ETFs that are showing leadership qualities. In Asia, that includes China ETFs while Mexico is showing signs of resuming its Latin America leadership perch.

Related: Look South For an Emerging Markets Rebound Play.

Among diversified funds, investors may want to consider an unheralded ETF that has broken away from the pack over the past month. The First Trust Emerging Markets AlphaDEX Fund (NYSE: FEM) has jumped 2.8 percent in the past month. That may not sound like much, but emerging markets ETFs are coming off a low base. Additionally, 2.8 percent in a month is 120 basis points more than the iShares MSCI Emerging Markets ETF (NYSE: EEM) and nearly triple the one-month returns offered by the Schwab Emerging Markets Equity ETF (NYSE: SCHE).

With just under $155 million in assets under management, FEM is smaller than its aforementioned rivals, but diminutive stature has not been empirically proven to be a valid reason to ignore an ETF. In the case of FEM, opting to ignore this ETF should emerging markets rebound in earnest could prove regrettable because First Trust’s AlphaDEX methodology has proven durable at the international level.

For example, the First Trust South Korea AlphaDEX Fund (NYSE: FKO) and the First Trust Canada AlphaDEX Fund (NYSE: FCAN) have outpaced rival South Korea and Canada ETFs this year, so it is plausible FEM can do the same in a legitimate emerging markets rebound.

FEM is dominated by China with the world’s second-largest economy accounting for 27.4 percent of the ETFs’ weight. That is a compelling attribute for FEM because China is leading the modest BRIC bounce that has been seen in recent days.

While no other country receives a weight of nine percent in FEM, the fund is not light on controversial country holdings. Protest-riddled Thailand and Turkey combine for 17.4 percent of FEM’s weight. These former emerging markets darlings have fallen on hard times in the past 90 days and their weights within in FEM are larger than in traditional diversified funds, implying some degree of added risk.

Brazil is another 8.3 percent of FEM’s lineup, indicating the fund is not lacking for previously beloved emerging markets that have frustrated investors this year. A sustained China rally along with contributions from some combination of Turkey, Thailand and Brazil would be enough to facilitate further upside for FEM.

FEM’s weights to China, Thailand and Turkey are well in excess of rival funds. For example, SCHE has a 20.3 percent weight to China and just a 3.1 percent allocation to Thailand. FEM is also more diverse at the sector level. Predictably, financial services lead the way at 18.9 percent, but that is wel below the 29.4 percent SCHE devotes to the sector.

FEM features weights ranging from 10.5 percent to 12.8 percent for materials, utilities, industrials and energy. Investors considering FEM as a medium- to long-term hold should consider this: Over the past year ending July 31, the Defined Emerging Markets Index, FEM’s underlying index, outpaced the S&P BMI Emerging Markets Index by 350 basis points, according to First Trust data.

For more on ETFs, click here.

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