This article is part of Your Guide to Emerging Markets. All this week, we are focusing on emerging markets, sharing their potential pitfalls – and where you can make a pretty penny.
Emerging market indices are less well-researched than the likes of the S&P 500 and FTSE 100. Because of this lack of transparency many investment experts encourage emerging market investors to use active managers when putting their fund portfolios together.
The generally accepted wisdom is that passive funds tend to be better options in more efficient markets such as the US, UK and parts of Europe.
However, that’s not necessarily the case. In fact, two of the three longest-running passive open-ended funds rated highly by Morningstar analysts have beat the average fund in the Investment Association’s Global Emerging Markets sector since October 2010, according to Morningstar Direct data. Over a one and five-year period, all three beat the sector average.
Of course, there are better-than-average active funds available, but passive funds give options for investors looking to access emerging market equities in a cheap fashion without the need for the ability to identify the best managers in the area.
Morningstar analysts have given Silver or Bronze ratings to two exchange traded funds and four open-ended trackers funds in the emerging markets equity category. We run through the longest-running four of these six vehicles, ranked by five-year performance, below.
Vanguard Emerging Markets Stock Index
This Vanguard offering fully replicates the MSCI Emerging Markets Index, invests in all its constituents. The fund has a Bronze Analyst Rating and has produced an annualised five-year return of 8.18% for investors. Over shorter timeframes, one and three years respectively, the numbers are more impressive at 9.35% and 12%.
Since inception in late June 2009, the fund is ahead of the IA Global Emerging Markets sector average, returning 128% to the average 122%.
Chinese stocks take up around a quarter of the portfolio; with A Shares now beginning to be included in its index, that proportion could rise to around 40%. Seven of the top 10 holdings are Hong Kong listed, including internet giants Tencent, Alibaba and Baidu. The three non-Chinese are Korea’s Samsung Electronics, Taiwan Semiconductor and South Africa’s Naspers.
The fund’s ongoing charges figure stands at 0.27%, which makes the vehicle “a very accurate index tracker and a competitively priced, above-average proposition in its category”, according to Morningstar analyst Monika Dutt.
Dimensional Emerging Markets Core Equity
This Silver Rated fund gives investors exposure to a more diversified basket of stocks than a vanilla index tracker would. Despite that, its performance figures of 8.17% annualised over five years and 12.09% over three years are similar to the Vanguard fund.
It does lag significantly over the past year, though, producing just 6.62% for holders. Still, it’s the longest running fund in the list and has well outpaced the IA sector’s average since inception in February 2004, returning 382% compared to 348%.
The fund invests in a broad range of EM equities, including stocks with market capitalisations as low as $50 million. However, Dutt points out that it “systematically tilts toward securities with characteristics that have historically been associated with market-beating performance”.
It overweights holdings with lower valuations, smaller market caps, and higher profitability. It also caps country weightings at 17.55, diversifying country-specific risk and meaning China isn’t as overwhelming an influence as it is on its competitors.
While the top 10 is dominated by familiar names, the order is different, with Samsung and Taiwan Semiconductor both, unusually, larger than Tencent. Other names such as Brazilian energy giant Vale and Korea’s SK Hynix also feature.
The fund is slightly more expensive than others at 0.67%, but still cheap compared to active counterparts.
L&G Global Emerging Markets Index
This fund, run by Legal & General and also holding a Bronze analyst rating, tracks the FTSE All World Emerging Index. The fund has returned an annualised 8% over a five-year timeframe, 10.45% over three years and 7.9% in the past 12 months.
It is, though, the only of the open-ended funds profiled here that has underperformed the IA sector average since its inception in October 2010, though only narrowly at 39.05% versus 39.5%.
While following a different index from the Vanguard fund, it has a broadly similar allocation, with a bias towards China. Although the weightings are not the same, there is only one difference in the top 10 holdings, with Brazilian bank Itau Unibanco in the L&G fund instead of Samsung.
The reason for the fund not owning Samsung is due to FTSE’s upgrade of South Korea to developed market status in 2009. “As a result, the FTSE index will slightly outperform when South Korean securities lose ground, and vice versa,” notes Dutt. “But over the long term, these differences will likely be negligible.”
Its fee is similarly low, at 0.33%. This makes it “highly competitive relative to both its active and passive peers”.
iShares Edge MSCI EM Minimum Volatility ETF (EMMV)
The only ETF in the list, this Silver rated fund reflects the return of the MSCI Emerging Markets Minimum Volatility index. Dutt points out that the nature of this ETF means it will tend to lag during bull markets, but will suffer less during bear markets. “It is also likely to see less dramatic downturns.”
As a result, it’s returned less than 20% since it floated in December 2012. While its longer-term results of 4.2% and 3.1% over three and five years respectively are not particularly impressive, it’s up 12.4% in the past 12 months – much more than the previous three featured funds.
The fund attempts to reduce volatility by setting out a number of constraints, including limiting turnover, exposure to individual names and sector tilts relative to the parent index. It should not be confused with a low-volatility portfolio, and may hold average to high-volatility stocks due to the risk diversification benefits they bring, says Dutt.
Its constraints do, though, make it a significantly different passive emerging market fund in its make-up. While it counts Tencent, Taiwan Semiconductor, Alibaba and China Mobile in its top 10 holdings, the rest of the list is different.
The top three holdings are financials: Indonesian PT Bank Central Asia Tbk, Malaysia’s Public Bank Bhd and Taiwan Cooperative Financial Holding Co. Elsewhere is Banco De Chile.
With fees of 0.4%, it’s still as cheap as its counterparts, too.
