The Vanguard MSCI Emerging Markets ETF (NYSEArca: VWO) is the third largest exchange traded fund on the market, with $38 billion in assets. The recent announcement that Vanguard will be making an index change to FTSE has investors pondering their choices.
“In early October, Vanguard announced that it is changing the fund’s benchmark from the MSCI Emerging Markets Index to the FTSE Emerging Index, and the most significant difference between the indexes is that South Korean equities (which currently account for 15% of the fund) are not part of the FTSE Index,” Patricia Oey wrote for Morningstar. [Emerging Market ETF Battle: Vanguard VS iShares]
The question goes much deeper than omitting South Korea from the index. Investors must also question if a cap-weighted approach is the best way to tap into emerging markets. Morningstar suggests that those investors who are able to walk away from traditional cap-weighted indexing should consider doing so for emerging markets exposure.
For one, since many emerging market large-cap companies are government-owned, economic and political interests come first, not the shareholder, reports Oey. Most private businesses are small or mid-cap sized, and therefore, are representative of consumption levels. Most market-cap weighted indices omit these companies and lose out on the growth potential. [iShares Emerging Market ETF Sees Inflow After Vanguard Index Swap]
The FTSE Emerging Index and the MSCI Emerging Markets Index are both cap-weighted, and the indices are very similar. The omission of South Korea is the major differential, and the country itself is very cyclical since it is a heavy technology manufacturer. As far as performance, there is a tight correlation between the two indices over the past three years, according to Morningstar. [Looking Beyond the Usual Suspects in Emerging Markets ETFs]
For those investors who are interested in a dividend approach to emerging markets, Morningstar says there are the following ETFs to consider for exposure:
- WisdomTree Emerging Markets Equity Income (NYSEArca: DEM) yields 3.7%
- SPDR S&P Emerging Markets Dividend (NYSEArca: EDIV) yields 6%
Vanguard MSCI Emerging Markets ETF
Tisha Guerrero contributed to this article.