This Emerging Markets ETF’s Exclusionary Tactics Are Working

The elephant in the emerging markets (EM) room is China, and not just because it’s the world’s second-largest economy behind only the U.S. By virtue of that heft, China is also, typically, the biggest geographic exposure in traditional diversified EM exchange traded funds.

Obviously, that’s good when China stocks are performing well and not so great when those stocks are lagging, as is the case today. Hence, the elephant in the room. However, investors can mute China risk in their portfolios via ETFs such as the KraneShares MSCI Emerging Markets ex China Index ETF (KEMX). The fund, which recently turned five years old, follows the MSCI Emerging Markets ex China Index.

As is the case with any other asset, there are potential risks and rewards with KEMX. The risk is that the ETF won’t directly participate in a China equity market rebound when that scenario materializes. The reward is that when Chinese stocks lag, KEMX won’t feel severe punishment. In fact, the KraneShares fund is higher by 12.72% over the past year — a period in which the MSCI Emerging Markets Index gained just 6.23%.

What Makes KEMX Click

A standard recipe employed by ex-China ETFs is to increase weights to India, South Korea, and Taiwan. KEMX follows suit, as those three countries combine for nearly two-thirds of the ETF’s geographic exposure compared to about 43% for the category average.

KEMX’s large weight to India has benefited investors, because while China stocks have struggled over the past several years, India equities have been among the best performers in the world — a trend that’s continuing this year. Likewise, KEMX’s elevated exposure to Taiwan tethers investors to a high-quality, tech-rich economy.

“Emerging-markets ex China funds tend to have more exposure to Brazil and Mexico, which have their own economic, social, and political downsides. Both countries have been accused of having corrupt governments, which have led to political uprisings,” noted Morningstar’s David Carey.

In terms of other developing markets, Brazil and Mexico are Latin America’s two largest economies. Carey’s assertion that both have had bouts with corruption and political volatility is accurate. KEMX’s allocations to those countries is above what’s found in a standard emerging markets fund. But the ETF devotes less than 13% of its total weight to stocks from that pair of nations.

Bottom line: KEMX and its peers aren’t perfect, but these products are worthy of consideration by tactical investors at a time when Chinese stocks are lagging.

“Emerging-markets ex China funds help solve some problems but create others. On one hand, they allow investors to minimize or eliminate China exposure, but they increase helpings in other developing markets with their own issues,” concluded Carey.

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