Emerging market ETFs have been more volatile than their underlying indices, according to recent media reports. Should investors be concerned?

Investment researcher Morningstar says no.

“In the month of June, the market price of iShares MSCI Emerging Markets (NYSEArca: EEM) had a volatility that was 27% greater than its index and an annualized tracking error of 25%. While that might sound alarming, the exchange-traded fund has actually functioned superbly,” writes Morningstar ETF analyst Michael Rawson. “The concern lies not with the fund, but with how volatility and tracking error are being used.” [ETF Premiums, Discounts and Volatility]

Bloomberg News in a separate report from July pointed out that share prices for the 10 largest diversified emerging-market ETFs “on average were 42.6% more volatile than their underlying indexes from May 22 to June 24, when comments by Federal Reserve Chairman Ben S. Bernanke triggered a selloff that sent emerging-market stocks to a one-year low.”

The story did note that providers said the extra volatility resulted from ETFs trading while the underlying emerging markets were closed or illiquid. “While the price swings have little impact on long-term investors, excess volatility can spur bigger losses if clients trade in times of market turmoil,” according to Bloomberg.

ETFs tracking international markets can trade at premiums or discounts to net asset value (NAV). These deviations occur because the ETFs continue to trade in the U.S. after the overseas markets close for the day.

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