Diversified emerging markets ETFs are supposed to be, well, diversified, but many of these funds feature some concentration risk, particularly at the geographic level.
For example, two of the category’s most popular funds, the iShares Core MSCI Emerging Markets ETF (NYSEArca: IEMG) and the Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) feature significant China exposure. IEMG’s China weight is 28.47%, or more than double the weight assigned to its second-largest geographic weight. As of the end of last year, VWO’s China weight was 33.7%, also more than double that of its second-biggest geographic weight.
Geographic concentration risk is one reason why these behemoth emerging markets ETFs are not rated higher by some analysts.
“The reason these low-cost options aren’t rated higher is they have large stakes in Chinese stocks, with roughly one third of their portfolios dedicated to companies listed in China,” said Morningstar in a recent note.
The research firm has Bronze ratings on IEMG and VWO.
What’s Next for the Chinese Market
“The Bronze rating isn’t a reflection of expectations about the Chinese market. Instead, it shows a lower level of confidence in the ability of these funds to perform well within the category, because they don’t diversify their country-specific risk as well as some of their actively managed competitors,” said Morningstar.
Recent data points indicate traders are buying some marquee ETFs tracking developing economies. After the recent pullback in the equities market, bargain hunters may look to beleaguered emerging market stocks and region-related ETFs for value.