Market Overview

This Emerging Markets ETF Should Be Less Bad

This Emerging Markets ETF Should Be Less Bad

An oft-cited reason for the ongoing bear market for emerging markets stocks and exchange-traded funds is the stronger U.S. dollar. The strengthening greenback has been particularly problematic for those developing economies that previously issued large amounts of dollar-denominated debt and major commodities producers.

For investors, the problem is that many traditional emerging markets ETFs are heavily allocated to commodities-producing countries, such as Brazil, meaning the rising dollar proves particularly punitive to those funds.

Fortunately, investors can skirt strong dollar issues while remaining allocated to developing economies with the WisdomTree Strong Dollar Emerging Markets Equity Fund (BATS: EMSD).

The 'Less Bad' Phenomenon

These days, the hallmark of a solid emerging markets is not so much “good” as it “less bad.” Since its late October debut, the WisdomTree Strong Dollar Emerging Markets Equity Fund has been less bad, falling 9.9 percent compared to a loss of nearly 19 percent for the MSCI Emerging Markets Index over the same period.

Related Link: Emerging Markets Have Some Appeal For Contrarians

While some ETFs have attempted to isolate developed markets companies positioned to benefit from favorable emerging markets growth trends, the WisdomTree Strong Dollar Emerging Markets Equity Fund goes the other way. The new ETF follows the WisdomTree Strong Dollar Emerging Markets Equity Index (WTEMSD), a benchmark that includes emerging markets firms that depend on the United States for at least 15 percent of their revenue.

EMSD's Formula For Success

EMSD's “secret sauce” really is not a secret. The ETF is not heavily allocated to commodities exporters such as Brazil and South Africa. Conversely, the ETF is heavily allocated to two of the more stable emerging stable emerging sectors: technology and consumer discretionary. Those sectors combine for over 62 percent of EMSD's weight.

Overall, EMSD excludes five of 10 sectors and with good reason.

<&ldquo>First, remember that commodities like oil are priced in U.S. dollars, and changes in their prices tend to move in the opposite direction of changes in the value of the U.S. dollar. One result is that stocks within the Energy and Materials sectors – closely connected to the commodities markets – tend to be sensitive to this phenomenon and exhibit returns that have a negative correlation to changes in the value of the U.S. dollar. Second, sectors like Financials, Telecommunication Services and Utilities are often highly leveraged,” said WisdomTree.

With that large technology comes a not-so-surprising large combined allocation to South Korea and Taiwan, which works in investors' favor because those are two of the most advanced, least volatile emerging markets. South Korea, Asia's fourth-largest economy, and Taiwan combine for 72 percent of EMSD's weight. India, which has been widely identified as a beneficiary of slumping oil prices, is 9.8 percent of EMSD's weight.

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