Emerging markets are off to a sluggish start to 2024. The Vanguard FTSE Emerging Markets ETF (VWO) was up 1.9% year-to-date through March 20, lagging the S&P 500 Index’s nearly 10% gain. Meanwhile, the iShares Core MSCI Emerging Markets ETF (IEMG) edged up 2.0%. Over the last three years, these broad emerging market ETFs have lost between 4%-5% in value on an annualized basis.
One of the culprits has been Chinese stocks. Indeed, the iShares MSCI China ETF (MCHI) and the Franklin FTSE China ETF (FLCH) declined 20% in the last three years. They were both down slightly in 2024.
High Demand for Ex-China ETFs
Some investors have turned to emerging markets ETFs that simply remove China from the index. The iShares MSCI Emerging Markets Ex-China ETF (EMXC) manages $12 billion in assets due to $7.7 billion of net inflows in the past year. Meanwhile, the Columbia EM Core Ex-China ETF (XCEM) has $920 million in assets, aided by $680 million of new money in the last 12 months. A third ETF, the KraneShares MSCI Emerging Markets ETF ex China ETF (KEMX) has doubled in size to $80 million.
During the VettaFi Equity Symposium this month, we covered two of these ex-China ETFs, and there was discussion from Columbia Threadneedle and KraneShares panelists about why Chinese stocks have underperformed. Indeed, these funds remove Chinese stocks without cause, unlike certain peer ETFs.
Freedom to Avoid Chinese Exposure
The Freedom 100 Emerging Markets ETF (FRDM) manages $775 million aided by $290 million of net inflows. The ETF launched in May 2019. FRDM’s index uses a country-specific screening criteria to measure the level of protection for personal and economic freedoms. These include freedom of expression, assembly and trade internationally. Data is provided by the Fraser Institute and the Cato Institute. Countries like Brazil, Chile, Poland South Korea, and Taiwan score high at present and are well represented. In contrast, there’s currently no exposure to China or India.
FRDM further excludes companies with high state ownership. Large-cap stocks such as Banco de Chile, Samsung Electronics and Taiwan Semiconductor are key holdings. FRDM was up 2.0% on an annualized basis in the last three years outpacing IEMG and VWO.
A More Democratically Friendly Global Approach
The Democracy International Fund (DMCY) has some similarities to FRDM but notable differences. DMCY is a global-ex US ETF that has higher exposure to democratic countries that support freedom of speech and civil liberties and lower allocations to authoritarian regimes that have human rights abuses and media censorship. The data behind these decisions stems from The Economist Magazine Democracy Index.
Countries like Canada, Japan, Switzerland, Taiwan and the United Kingdom are overweighted relative to a broad market global ex-US index, while China and India are underweighted. DMCY currently owns a combination of international equity ETFs like the iShares MSCI Taiwan ETF (EWT) and individual stocks like ASML Holdings and Nestle.
In 2022 and 2023, DMCY’s total return was ahead of the Vanguard FTSE All World ex-US Index Fund (VEU) by more than 100 basis points. DMCY will turn three years old at the end of March. The ETF is relatively small with approximately $10 million in assets.
Advisors and end clients can better control the country exposure of their international allocations using ETFs.
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