Avoiding Lumbering State-Run Companies in Emerging Markets

Traditional emerging markets ETFs often feature substantial allocations to companies that are majority-owned by governments and that’s not always a positive trait for investors. The WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (NYSEArca: XSOE) is an ETF dedicated to avoiding some the issues associated with owning state-controlled equities.

XSOE seeks to track the price and yield performance of the WisdomTree Emerging Markets ex-State-Owned Enterprises Index. Under normal circumstances, at least 80% of the fund’s total assets will be invested in component securities of the index and investments that have economic characteristics that are substantially identical to the economic characteristics of such component securities. The index is a modified float-adjusted market cap weighted index that consists of common stocks in emerging markets, excluding common stocks of “state-owned enterprises.”

State-owned enterprises (SOEs) are common in emerging markets strategies and are often prominent in three sectors – energy, financial services and materials – through telecom and utilities, in some markets, have their share of SOEs, too.

Examining XSOE’s Weight

Financials are XSOE’s third-largest at 16.81%, but energy and materials names combine for less than 13% of the fund’s weight.

“Precisely estimating the impact of political risk on an SOE’s share price isn’t necessary to make some informed decisions about investing in them or emerging markets more broadly,” said Morningstar in a recent note. “Government ownership of these stocks invariably creates some risk. The likelihood this risk will rear its head and the magnitude of its impact will vary across time and markets.”

As Morningstar notes, XSOE’s sector construction is important.

“XSOE had far less exposure to the financials sector and mildly underweights the materials and energy sectors. It has also tended to overweight consumer and technology stocks. Consequently, it has historically tilted toward growth stocks, which has aided its performance over the past several years,” according to the research firm.

Related: Excellence in Emerging Markets Income 

XSOE’s structure has positively impacted performance over time.

“From its launch in December 2014 through July 2019, it beat the MSCI Emerging Markets Index by 73 basis points annually. Its 0.32% expense ratio is higher than the lowest-cost emerging-markets index funds, but it is still cheaper than most of the actively managed choices in the diversified emerging markets Morningstar Category,” according to Morningstar.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.