ETF Trends
ETF Trends

Traditional emerging market investors may be overexposed to regional risks. Instead, traders may consider an alternative to cap-weighted index strategies, such as a smart-beta exchange traded fund that takes a more balanced macro approach the the developing countries.

On the upcoming webcast, Define Your Emerging Market Smart Beta Strategy, Mike LaBella, Portfolio Manager at QS Investors, and Brandon Clark, Director & Product Manager at Legg Mason Global Asset Management, will explain the potential pitfalls of a cap-weighted emerging market approach and offer a potentially better way to access the developing economies.

Related: Emerging Market ETFs Are Turning Around

Positive economic development over the past two decades has supported emerging markets. However, the positive momentum is not shared equally with the broad emerging market group. Developing economies are heterogeneous with significantly variant economic, political and developmental differences.

Consequently, investors should be aware of the potential opportunities and risks that the divergence reflects in the emerging markets.

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Looking at some of the most popular emerging market funds, many track widely observed market capitalization-weighted benchmarks like the MSCI Emerging Markets Index. However, these benchmarks are highly concentrated to some single countries – the MSCI benchmark includes over 50% exposure to just China, South Korea and Taiwan, and the FTSE Emerging Market Index may raise its China exposure to 50% over time.

Consequently, investors may consider alternative index-based emerging market ETFs that focus on quality and diminish exposure to riskier areas as a way to diversify across developing countries and generate improved risk-adjusted returns over the long haul.

For instance, the Legg Mason Emerging Markets Diversified Core ETF (NasdaqGM: EDBI) breaks down the universe of securities into investment categories based on sectors and countries. The five-year return patterns of the countries and sectors are taken to uncover relationships – areas that behave alike or differently. The underlying index then combines investment categories with more highly correlated historical performance into smaller number of so-called clusters, which are categorized based on tendency to behave similarly, or show various correlations. Each of these clusters are then equally weighted individually and also equally weighted across the portfolio to produce a diversified investment strategy.

Related: Did Emerging Markets Just Deliver Another Head Fake?

Specifically, among its top country weights, EDBI only includes a 13.4% tilt toward China, followed by Malaysia 9.3%, India 8.9%, Turkey 7.8% and South Africa 7.1%. Additionally, while financials are still a major component, the financials sector only makes up 15.9% of EDBI’s portfolio.

Financial advisors who are interested in learning more about investing in the emerging markets can register for the Tuesday, June 14 webcast here.