Play a Bounce in Growth and Emerging Markets With This ETF

Investors looking at emerging markets and having an “aha moment” might be wondering if a bounceback play is in the works. While it’s possible, headwinds abound, making it necessary to look at the opportunity with a discerning screener.

“Russia’s invasion of Ukraine is supercharging food and fuel prices and stoking a cost-of-living crisis across the globe. However, the worst effects are yet to kick in. As rising inflation and government cutbacks bite households harder, we see a rise in civil unrest as inevitable across key emerging economies that will have likely knock-on impacts on political stability and investor confidence.

“Middle-income economies struggling with the public purse will be most at risk,” the report added. “According to our Civil Unrest Index Projections, 10 of these countries – including Brazil, Egypt, Tunisia, Pakistan, and Senegal – are in line to take the hardest hit over the next six months.”

An ETF With a Discerning Screener

Investors or advisors can do their own research with respect to emerging market equities, but an easier way is to look at exchange-traded funds (ETFs), particularly those with a discerning screener that focuses on quality. One such fund is the First Trust Emerging Markets Small Cap AlphaDEX® Fund (FEMS).

The fund seeks investment results that correspond to the Nasdaq AlphaDEX® Emerging Markets Small Cap Index. The Index is an “enhanced” index created and administered by Nasdaq, Inc. which employs the AlphaDEX® stock selection methodology to select stocks from the NASDAQ Emerging Markets Index that meet certain criteria.

How the index is constructed per the First Trust product website:

  • Nasdaq ranks the eligible stocks on growth factors including 3-, 6- and 12- month price appreciation, sales to price, and one-year sales growth, and separately on value factors including book value to price, cash flow to price, and return on assets. All stocks are ranked on the sum of ranks for the growth factors and, separately, all stocks are ranked on the sum of ranks for the value factors. A stock must have data for all growth and/or value factors to receive a rank for that style.
  • Each stock receives the best style rank from the previous step as its selection score.
  • The top 200 stocks based on the selection score determined in the previous step comprise the “selected stocks”. The selected stocks are divided into quintiles based on their rankings and the top-ranked quintiles receive a higher weight within the index. The stocks are equally-weighted within each quintile.
      • If the weight assigned to the stock, when added with the weight assigned to all higher ranking stocks in its country/sector, is greater than the constraint, then the stock’s weight is lowered to the highest rank in the next quintile. Stocks previously lower in rank then move up one rank. Such stocks in the lowest quintile that violate a constraint are removed from the portfolio and replaced by the highest scoring stock not originally selected, subject to country/sector constraints. This process continues until all the country/sector weightings meet the constraint. Each stock is then tested in order of its selection score rank to check if the weight assigned to that stock is outside the country/sector weighting constraints, which are set at 15% above the benchmark weight.

For more news, information, and strategy, visit the Nasdaq Investment Intelligence Channel.

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