Nevertheless, potential investors should be aware that not all emerging markets are created equal. While ETF options like EEM and VWO track major emerging market indices, these ETFs follow market capitalization-weighted indices that could overexpose investors to a few large countries or a specific sector.
For instance, EEM includes a 25.4% tilt toward China, 14.4% to South Korea and 12.0% to Taiwan, along with a hefty 25.7% weight toward the financials sector. Meanwhile, VWO holds a large 28.4% China weight, 15.3% in Taiwan and 12.5% in India, along with 24.2% in financials.
Alternatively, as a way to diversify country and sector exposure, investors may consider smart-beta or alternative index-based ETFs that are less top heavy, compared to traditional beta-index ETFs. With the recent surge in smart-beta interest, ETF investors now have a number of new alternative emerging market options to choose from.
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For example, 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. EDBI is less top heavy, with 13.8% China, 9.5% India and 9.0% Malaysia, among its top holdings. The financial sector also only makes up 15.8% of the portfolio.
The JPMorgan Diversified Return Emerging Markets Equity ETF (NYSEArca: JPEM) tracks the FTSE Emerging Diversified Factor Index, which incorporates a multi-factor screening process that combines value, momentum and quality factors. JPEM’s top country weights include China 18.5%, Taiwan 18.3% and India 8.2%.
The Deutsche X-trackers FTSE Emerging Comprehensive Factor ETF (NYSEArca: DEMG) tries to reflect the performance of the FTSE Emerging Comprehensive Factor Index, which targets emerging market equities based on five factors, including quality, value, momentum, low volatility and size. DEMG’s top countries include China 15.1%, South Africa 14.8% and Taiwan 12.7%.