ETF Trends
ETF Trends

Emerging market stocks and related exchange traded funds have been unloved over past couple of years as developed markets outperformed. However, some are shifting back to the more attractively valued developing countries.

Over the past five years, the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) generated an average annual return of 0.7% and the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) averaged a 0.3% decline. Meanwhile, the S&P 500 index averaged a 16.0% return. [Look to Emerging Market ETFs in the Second Half]

“It’s a fallacy to believe that EMs are on an escalator to DM status,” Richard Titherington of JPMorgan Asset Management told the Financial Times. “There are times when they will do better and times when they will do worse.”

Consequently, investors should look at the emerging market equities as a more cyclical asset. Currently, after years of outperformance in the developed markets, the emerging markets are beginning to show a lower premium to more developed countries.

“It’s too early to say that EM valuations have turned the corner but they are clearly at the low end of a historic range,” Titherington added. “Because it’s a cyclical asset class, you know the turn will happen at some point. You don’t buy EMs because they will emerge, you buy them because they are cheap.”

For example, VWO is trading at a 13.49 price-to-earnings and a 1.65 price-to-book, and EEM shows a 12.64 P/E and a 1.5 P/B. In contrast, the S&P 500 has a 18.57 P/E and a 2.48 P/B.

Due to the cheaper relative valuations, many money managers have also slowly added more emerging market exposure. According to data from Copley Fund Research, which tracks investments of 120 dedicated global EM equity funds with $290 billion in assets, the average weighting in developed market shares among the funds it covers rose from 6% at the beginning of 2011 to a peak of 9.3% in February 2014, but it has since dipped to less than 7% in June. Over the same periods, emerging market company allocations fell from 88% to 85% and are now back up to 88%.

The shifting attitudes have also been mirrored in the ETF market as emerging market funds attracted greater interest. Over the past year, VWO saw $2.7 billion in net inflows, according to ETF.com. While EEM lost $11.1 billion in outflows, the iShares Core MSCI Emerging Markets ETF (NYSEArca: IEMG) experienced $3.2 billion in inflows, which suggests that investors are favoring the cheaper “core” iShares emerging market product over the older option – IEMG has a 0.18% expense ratio, compared to EEM’s 0.69% expense ratio.

For more information on developing economies, visit our emerging markets category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.