A Cost-Effective Way To Tap Emerging Markets Stocks

Plenty of advisors and increasing number are likely aware that emerging markets equities have spent several years being duds relative to U.S. equivalents.

Sure, there have been clear pockets of strength in developing economies, but broad-based funds – the primary avenue through which many advisors allocate to emerging markets – have left a lot to be desired. Over the past three years (the lag is actually much longer), the MSCI Emerging Markets Index slid 15.6% while the S&P 500 gained almost 28%. Predictably, EM stocks were also more volatile than domestic counterparts, underscoring the point that’s there been no reward for the risk incurred with diversified emerging markets equity funds.

There’s another side to the story. Some developing economies, including large ones, offer noteworthy rates of economic growth and there’s no shortage of market observers claiming that it’s time for international stocks to outperform, that those equities are inexpensive, or both.

Speaking of inexpensive, that’s the way to go for investors willing to exercise patience in emerging markets. Enter the Vanguard FTSE Emerging Markets ETF (VWO).

VWO Solid Idea for EM Exposure

When acknowledging that it could take awhile for an earnest emerging markets rebound to materialize, VWO is all the more compelling for advisors due to its annual fee of 0.08%. That compares with the category average of 1.14%, according to Vanguard data. Additionally, VWO is diverse at the holdings level.

“The portfolio’s extensive diversification mitigates the impact of the worst-performing positions. As of December 2023, it held over 4,700 stocks, and its 10 largest positions accounted for less than 18% of its assets. The ETF switched to its current benchmark in 2016 and has provided exposure to locally traded China A-shares since then, further expanding its reach,” notes Morningstar analyst Lan Anh Tran.

Regarding geographic exposures, advisors should note that as its name implies, VWO follows a FTSE Russell benchmark. That index provider classifies South Korea as a developed market where as rival MSCI does not. That means there are no South Korean equities among the 5,848 held by this exchange traded fund.

Amid concerns that South Korea is currently on pace for Japan 1990s-style economic malaise, VWO’s lack of exposure to that country could be advantageous. That’s already played out in real time as the Vanguard ETF outperformed the MSCI Emerging Markets by 670 basis points over the past three years. With South Korea out of the equation, VWO was less bad than some of its rivals due in part to elevated exposure to India and Taiwan.

VWO Pros and Cons

Clearly, VWO offers clients the benefits of a low and a deep bench in terms of number of holdings. Plus, the overweights to India and Taiwan have proven beneficial.

Still, the ETF needs some China (26.90% of the portfolio) to pick up some slick and could be left vulnerable if South Korean stocks rally.

“The ETF lagged its category average by 4.45 percentage points between July 2022 and June 2023. Its heavy stake in emerging Asian markets disappointed in this period, particularly its positions in Chinese stocks,” adds Tran. “It also treaded lightly on better-performing Latin American markets. Underweighting emerging European markets briefly helped the ETF’s returns in the first half of 2022 as these economies suffered from geopolitical turmoil in the region.”

The point is like any other ETF, VWO has its advantages and its drawbacks.

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