Waiting For Godot: Emerging Markets ETFs Try To Get It Together

Barring a turnaround of epic proportions, this will go down as another disappointing year for emerging markets equities and the corresponding exchange-traded funds.

With just over 40 days left in 2015, the Vanguard Emerging Markets Stock Index Fd VWO and the iShares MSCI Emerging Markets Indx (ETF) EEM, the two largest emerging markets ETFs, are off an average of 11.4 percent year-to-date.

Single-Country Emerging Markets ETFs

An array of single-country emerging markets ETFs, (looking at you, iShares MSCI Brazil Index (ETF) EWZ) have been far worse than EEM and VWO. In the absence of the aforementioned epic rally, 2015 will be the third consecutive year in which EEM and VWO have trailed the S&P 500 and the MSCI EAFE Index, as well as being the fourth year in the past five.

Related Link: Just How Inexpensive Are Emerging Market ETFs?

Emerging Markets And The Investor

So, it is not surprising that investors' patience is being tested with emerging markets stocks. Nor is it surprising those investors are losing patience. For example, EEM and VWO have bled over $9.1 billion in assets this year. With the Federal Reserve positioned to raise interest rates next month, emerging markets ETFs could suffer additional outflows.

“But when investors believe the Fed will, in fact, raise rates sooner than that, they may very well reduce their EM exposure. We saw this in early November, when a positive labor market report caused investors’ expectations of the probability of a Fed hike in December to rise from 56 percent on November 5 to roughly 70 percent the following day as measured by the pricing of federal funds futures, according to Bloomberg.

“EM stocks sold off on the news, with the index down roughly 4 percent since November 5, based on Bloomberg data as of November 9,” reported an iShares note.

ETFs with exposure to developing economies with sovereign credit issues, such as EWZ and the Ishares Msci Turkey Inv Market Index Fd TUR, are seen as especially vulnerable to hawkish changes in Fed policy. The iShares MSCI Emerging Markets Minimum Volatility ETF (iShares Inc. EEMV) can help investors ameliorate that scenario.

Looking At EEMV

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.

Related Link: Getting Contrarian With Emerging Markets ETFs

EEMV is down 10.2 percent this year, but the ETF has avoided the outflows bug on its way to adding over $1.1 billion in new assets. With negligible exposure to the most volatile emerging markets (EEMV's weight to Brazil is scant and Russia is not featured in the portfolio), EEMV is a conservative avenue to emerging markets at a time of contracting earnings and a possible Fed rate hike.

“Whether a Fed rate rise comes before December 31 or not, it’s likely to come eventually. In addition, many EMs are forecasted to continue to experience weak economic growth and geopolitical issues. So while EM valuations are relatively cheap, they may remain cheap for some time, and could even get cheaper from here,” added iShares.

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