The developing markets have been falling behind developed stocks for the past few years, but as once outperforming plays grow long in the tooth, investors are taking a second look at the more cheaply valued emerging market exchange traded funds.
Over the past five years, the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) and iShares MSCI Emerging Markets ETF (NYSEArca: EEM), the two largest emerging market plays, generated an average annualized return of -4.2% and -4.8%, respectively, while the S&P 500 Index returned 11.9%.
However, the developing markets are gaining momentum. Year-to-date, VWO increased 9.0% and EEM rose 8.8% while the S&P 500 Index gained 3.6%.
The emerging markets have been stabilizing and we are seeing increased flows into the space. Over the past week, VWO added $141 million in net inflows and EEM saw $47 million in inflows. The iShares Core MSCI Emerging Markets ETF (NYSEArca: IEMG), a slightly cheaper and more diversified option to EEM, attracted $255 million.
As commodity prices rebound and the emerging currencies appreciate, investors are taking notice of the attractive valuations that the developed markets have to offer. For instance, VWO shows a 12.51 price-to-earnings ratio and a 1.42 price-to-book. EEM has a 12.06 P/E and a 1.28 P/B, according to Morningstar data. In comparison, the S&P 500 is trading at a 17.22 P/E and a 2.34 P/B. Bargain hunters who are seeking a deal may find that the discount in emerging equities to U.S. equities is an attractive opportunity.
Moreover, as investors shift away from the growth style in favor of value, alternative or smart beta index-based ETFs, which typically exhibit a value tilt, may also gain traction.
For example, the WisdomTree Emerging Markets High Dividend Fund (NYSEArca: DEM) tracks a fundamentally weighted index that includes the highest dividend yielding stocks taken from the WisdomTree Emerging Markets Dividend Index and are weighted by annual cash dividends paid. DEM shows a 4.70% 12-month yield. DEM has a 9.18 P/e and a 1.08 P/B and increased 16.0% year-to-date.
There are a number of so-called smart-beta, enhanced, multi-factor or fundamental emerging market ETF options available as well. Among the largest options, the Schwab Fundamental Emerging Markets Large Company ETF (FNDE) tracks the Russell Fundamental Emerging Markets large Company Index, which selects, ranks and weights components based on fundamental factors like adjusted sales, retained operating cash flow and dividends plus buybacks. FNDE has a 9.67 P/E and a 0.78 P/B and rose 19.6% year-to-date.
The PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca: PXH), which tracks the FTSE RAFI Emerging Markets Index, is a fundamentally-weighted ETF focusing on the virtues of book value, cash flow, sales and dividends. PXH has a 10.18 P/E and a 0.91 P/B and advanced 18.7% so far this year.
The First Trust Emerging Markets AlphaDEX Fund (NYSEArca: FEM) is based on growth factors like three, six and 12-month price appreciation, sales to price and one year sales growth, along with value factors, including book value to price, cash flow to price and return on assets. FEM has a 10.15 P/E and a 1.03 P/B and returned 9.2% year-to-date.