More Reasons To Like Emerging Markets ETFs

In professional sports, some leagues have a comeback or most improved player of the year award. If such an award existed in the world of exchange-traded funds, any number of emerging markets funds would qualify this year.

The widely followed MSCI Emerging Markets Index is up 16.3 percent year-to-date. That is more than doubled the combined gain of the S&P 500 and the MSCI EAFE Index. Emerging markets ETFs' renaissance is being backed by investors' capital and plenty of it. As of October 25, three of this year's top 10 asset-gathering ETFs are emerging markets funds. To put that number into perspective, it matches the number of U.S. equity funds on the list and is ahead of the number of bond ETFs on the top 10 list.

The iShares Core MSCI Emerging Markets ETF (iShares Inc. IEMG) has returned nearly 16 percent and year-to-date. Good news for investors that think they have missed out on the resurgences delivered by IEMG and rival ETFs: There might be more upside on the way. Some fundamental factors bode well for ongoing emerging markets upside.

“With lower external debt than other regions, Asian economies have been less vulnerable to a strengthening U.S. dollar, which remains one of the main risks to our outlook for emerging markets. Controlled inflationary pressures also support our expectation of further policy accommodation by Asian central banks,” said BlackRock in a recent note.

Debt-To-GDP

IEMG, which recently saw its annual fee reduced, making it one of the least expensive emerging markets ETFs on the market, features considerable Asia exposure. For example, China, South Korea and Taiwan combine for about 52 percent of IEMG's geographic weight. Eight of the ETF's top 12 country weights are Asian nations, all of which have vastly superior debt-to-GDP ratios compared to the United States and the eurozone.

Compelling Valuations

In addition to those tidy debt-to-GDP ratios, many developing economies still trade at compelling valuations despite this year's move higher, indicating investors will not necessarily pay up for emerging markets exposure.

“Earnings revisions have improved across emerging markets, with Asia leading the way in terms of return-on-equity. In addition, EM Asia dividend yields currently rival those of developed markets, based on the MSCI Emerging Markets Asia Index. With a current price-to-book of 1.57, valuations remain reasonable relative to both developed and emerging markets,” added BlackRock.