Developing country stocks have rebounded this year, finally beginning to pull ahead of developed markets, with emerging market exchange traded funds that track customized or smart beta indices leading the charge.
A combination of cheap valuations and improved corporate earnings are supporting the rebound in emerging market stocks.
“EM equities have outperformed their developed counterparts in 2016, reversing a five-year run of dramatic underperformance,” BlackRock strategists said in a note. “The EM rebound has coincided with a recovery in corporate profitability relative to the developed world.”
“Valuations are still cheap, with the EM world’s price-to-book ratio one standard deviation below its long-term average,” the strategists added.
The Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) and iShares MSCI Emerging Markets ETF (NYSEArca: EEM), the two largest emerging market plays, have only generated a 0.7% and 1.8% average annualized return over the past five years, compared to the S&P 500’s 13.8% annualized return. However, emerging markets are outperforming in 2016, with EEM up 18.2% and VWO 19.4% higher year-to-date while the S&P 500 rose 7.0%.
Among the best performing emerging market ETFs around, funds that track alternative or factor based indexing methodologies have outperformed, notably those with a greater value tilt.