Emerging markets equities and the related exchange traded funds have been among 2017’s best-performing assets. Though not free of risk, that theme is expected to continue in 2018. With cap-weighted strategies having surged in 2017, investors may want to consider fundamentally-weighted options in 2018, such as the Deutsche X-trackers FTSE Emerging Comprehensive Factor ETF (NYSEArca: DEMG).
In an extended bull run, U.S. markets have rallied to record highs but they are now trading at lofty valuations relative to historical averages. On the other hand, international markets that have mostly lagged behind the outperformance in U.S. equities, prior to this year, remain attractively priced.
Discounted valuations, especially in an environment where U.S. equities are trading near record levels, provide a relatively attractive opportunity for investors. Even after the strong start to this year, current price-to-earnings ratio of MSCI EM is around 15.1, compared to the 22.2 for MSCI USA Index. DEMG follows the FTSE Emerging Comprehensive Factor Index.
Emerging markets are enjoying improved fundamentals thanks to corporate earnings improving as economic growth rebounds and strengthening currencies against the U.S. dollar on the back of improved economic outlooks.
DEMG tracks the FTSE Emerging Comprehensive Factor Index, which “is designed to provide core exposure to emerging market equities based on five factors – Quality, Value, Momentum, Low Volatility and Size,” according to Deutsche Asset Management.
That strategy gives DEMG an extra layer to potentially benefit investors because most multi-factor ETFs provide exposure to three or four investment factors.
DEMG holds just over 800 stocks and its largest country weight is 18.5% to China, significantly less than the China exposure found in the MSCI Emerging Markets Index. DEMG allocates a combined 28% of its weight to Taiwan and South Africa.
Emerging markets equities still trade at a discounts relative to U.S. benchmarks, but the utility of the quality factor in the developing world cannot be understated. Historically, when emerging markets stocks decline, it is lower quality names driving those declines. DEMG’s emphasis on quality can help investors capture emerging markets upside while potentially limiting downside.
DEMG allocates a combined 26.6% of its weight to industrial and financial services stocks. The ETF’s 10% weight to the energy sector could be interesting heading into 2018 as emerging markets energy stocks are trading at steep discounts to their long-term averages.
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