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Fantastic Fundamental Application With This Emerging Markets ETF

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Fantastic Fundamental Application With This Emerging Markets ETF

Emerging markets exchange-traded funds are on the mend in 2016. Only time will tell how long that trend will last, but what is left of the emerging markets bull camp after several years of dour performances will likely reiterate that developing world equities are still nowhere close to previous highs and are still inexpensive on valuation.

Assuming the notion that there is more gas left in the tanks of emerging markets stocks and ETFs, investors might do well to evaluate different kinds of ETFs. That includes the PowerShares FTSE RAFI Emerging Markets Portfolio (NYSE: PXH). PXH is already delivering for investors, posting a year-to-date return of 12.3 percent, or better than double the returns offered by the MSCI Emerging Markets Index.

A simple way of looking at PXH is that as a fundamentally-weighted ETF, the fund is the emerging markets equivalent of the wildly popular PowerShares FTSE RAFI US 1000 (ETF) (NYSE: PRF). PRF is widely seen as one of the ETFs that kick-started the smart beta movement.

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PXH competes with some other fundamentally-weighted emerging markets ETFs. This ETF's recipe boils down to an index where the member firms are “selected based on the following four fundamental measures of firm size: book value, cash flow, sales and dividends. The equities with the highest fundamental strength are weighted according to their fundamental scores,” according to PowerShares.

China And Others

Like many emerging markets ETFs, PXH features China as its largest country weight to the tune of 24.7 percent. However, PXH separates itself from cap-weighted rivals with significant overweights to two countries that were previously drags on emerging markets ETFs. PXH allocates 21.6 percent of its weight to Brazilian stocks and almost 9.7 percent to Russian stocks. Conversely, the MSCI Emerging Markets Index allocates barely more than 10 percent of its weight to those two BRIC members.

While the familiar criticism of smart beta ETFs is that when they outperform, they do so because of the value or small-cap factors, PXH faces other potential hurdles or catalysts depending upon one's point of view. Those being the ETF's large allocations to financial services and energy stocks.

Those sector allocations are hallmarks of U.S.-focused value ETFs, but in an emerging markets fund, it also means big exposure to state-controlled companies. PXH devotes over 55 percent of its weight to financial services and energy companies and more than half of the ETF's top 10 holdings are state-controlled firms.

Those controversial companies were previously burdens on emerging markets ETFs, but that theme is changing this year. The risk for PXH is that governments, particularly Brazil's, will give investors reasons to sour on state-run firms once again.

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