This has been another disappointing and turbulent year for emerging markets exchange traded funds. Amid faltering currencies, tumbling commodities prices and geopolitical tensions, 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 7.2%.
Barring a late-year rally of miraculous proportions, VWO and EEM will close the year in the red for third time in the past five years. Investors have not displayed much patience for developing world stocks and ETFs this year.
As of the end of November, a mere $700 million had been allocated to emerging markets ETFs this year with EEM and the WisdomTree Emerging Markets Equity Income Fund (NYSEArca: DEM) residing among the 10 worst ETFs for 2014 outflows.
However, opportunity often emerges from crisis and that could be the way to approach emerging markets ETFs heading into 2015.
“Valuations are relatively less expensive, with EM trading at a 31% discount to the 12-month forward P/E of the MSCI World Index,” according to a new report by Emerging Global Advisors, the parent company of ETF issuer EGShares.
EGShares highlights several other catalysts that could lift emerging markets ETFs next year. For example, investors are the most underweight developing world stocks that they have been at any point in the past decade although emerging equities are expected to sport 2015 EPS growth of 8.2% while return on equity is expected to grow 12.5%, according to EGShares data. [Be Picky With EM ETFs]
Still, investors will need to remain selective with emerging markets ETFs in the new year. That includes employing a preference for Asian economies over emerging Europe and Latin America equivalents while also focusing on reform-minded economies.
“Non-commodity cyclical sectors (Consumer Discretionary, Financials and, to a lesser extent, Industrials) are the most attractive on a Price/Earnings to Growth (PEG ratio) basis,” according to EGShares. “The defensive sectors (Health Care and Consumer Staples) do not appear to be unreasonably valued on this metric.”
One ETF that can help investors emphasize will gaining exposure to reforming economies is the EGShares Emerging Markets Core ETF (NYSEArca: EMCR). While EMCR does feature substantial Latin America exposure (Brazil is 10.3% of the fund’s weight), 10.3% of that weight goes to reform-minded Mexico. Earlier this year, Mexico passed legislation opening its energy industry for the first time in decades. However, stocks there have tumbled this year. [Mexico ETF Derailed by Economic Weakness]
For its part, EMCR is off just 3.5%, marked outperformance of EEM and VWO, and the EGShares offering allocates over 44% of its weight to Asian economies, including reform-minded countries such as India, Indonesia and the Philippines.