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Just How Inexpensive Are Emerging Market ETFs?

November 17, 2015 8:12 am
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Just How Inexpensive Are Emerging Market ETFs?

There are at least two certainties regarding emerging markets stocks and exchange traded funds. First, 2015 is set to be another year of slack performance for emerging markets ETFs as the Vanguard FTSE Emerging Markets ETF (NYSE: VWO) and the iShares MSCI Emerging Markets ETF (NYSE: EEM) are off an average of 12 percent.

Second, throughout much of this now multi-year emerging markets slump, investors keep hearing how inexpensive developing world equities are. However, what appear to be compelling valuations have not been enough to lure investors back to this asset class.

Confidence in foreign reserves usually comes with investors having confidence in a country's currency. With that in mind, it is not surprising that ETFs tracking emerging markets with weak currencies, such as the iShares MSCI South Africa ETF (NYSE: EZA) and the iShares MSCI Brazil Capped ETF (NYSE: EWZ) have been drubbed this year. EWZ has already endured a downgrade to Brazil's sovereign debt rating while market participants eye EZA as potentially suffering a similar fate.

"Per Research Affiliates’ expected return data, emerging-markets stocks (as represented by the MSCI Emerging Markets Index) had the highest expected returns of any major asset class as of the end of September. Research Affiliates’ data also show the current Schiller P/E ratio for emerging-markets stocks, at 11, its lowest level ever, and well below its median value of 19," according to a recent Morningstar research note.

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The iShares MSCI Emerging Markets Minimum Volatility ETF (NYSE: EEMV) has been slightly less bad than traditional, diversified emerging markets ETFs this year. Low volatility in emerging markets usually means large weights to Malaysia, South Korea and Taiwan. Those countries combine for almost 38 percent of EEMV's weight, well above the roughly 31 percent EEM allocates to that trio.

"EEMV is less risky than its broad cap-weighted peers by design. This has panned out in practice recently, as evidenced by its lower drawdowns and lesser volatility relative to its market-cap-weighted peers like EEM," said Morningstar.

Investors should keep in mind that there is always a difference between "value" and "value trap" and that is apparent in emerging markets. After all, anemic earnings growth has been a primary catalyst in driving developing world equity valuations lower. Brazil and EWZ arguably have sported the value trap look this year.

"EWZ is now trading at a level lower than where it bottomed out at the nadir of the global financial crisis, as local equities have hit the skids and the value of the Brazilian real has fallen," according to Morningstar.

The largest Brazil ETF is down 33.3 percent year-to-date.

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