The Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) and the iShares MSCI Emerging Markets ETF (NYSEArca: EEM), the two largest emerging markets ETFs by assets, are down an average of 7.1% this year.
In another sign that intelligent indexing can work for ETF investors, those developing markets funds that subscribe to a factor-based weighting methodology have been less bad than their cap-weighted peers this year. [Low Volatility ETFs for Emerging Markets]
While cap-weighted emerging markets ETFs are large, liquid and highly popular with investors, there are drawbacks with these ETFs as well. “Most long-term investors who have an interest in emerging markets know that these ETFs are not the best funds to capitalize on the long-term growth opportunity in emerging markets, due to their market-cap-weighting approach,” says Morningstar analyst Patricia Oey.
As Oey notes and has been frequently highlighted in the past, cap-weighted emerging markets ETFs have come under criticism for, among other “offenses,” being too heavily allocated to Brazil and China, excessive weights to state-run firms and not enough exposure to the consumer story. [A Case for the Emerging Markets Consumer]
Factor-based ETFs can help investors avoid some of the drawbacks of cap-weighted emerging markets funds. Investors may already be familiar with some of the options, including the WisdomTree Emerging Markets SmallCap Dividend Fund (NYSEArca: DGS).
Although small-caps are seen as more volatile than their larger peers “DGS’ volatility has been lower than that of the large-cap benchmark MSCI Emerging Markets Index over the past five years. This is because DGS has somewhat of a quality tilt thanks to its dividends-paid weighting methodology,” according to Morningstar.