A Smart Way for ETF Investors to Capture Emerging Market Growth

Investors who are looking into emerging-market stocks may consider the merits of a multifactor, smart beta ETF approach to access this market segment and diminish potential downside risks.

On the recent webcast (available On Demand for CE Credit), Emerging Markets: When the time is right, will you be ready?, Matthew Miskin, Market Strategist at John Hancock Investments, explained the long-term benefits of emerging market exposure. The developing economies may appear riskier as opposed to its more stable and developed counterparts, but the benchmark MSCI Emerging Market Index has exhibited a better risk-adjusted return over the long term.

Since the end of 2000, the MSCI Emerging Market Index showed a Sharpe ratio of 0.36, compared to the lower 0.33 Sharpe ratio for the MSCI USA Index, 0.26 for the MSCI All Country World Index and 0.17 MSCI EAFE Index. Miskin attributed the better returns to earnings as a key factor in their rebounds after periods of volatility.

Furthermore, while the U.S. dollar has weighed on international equity demand, Miskin argued that the U.S. dollar may be in the topping process. A flat or weaker dollar outlook would help investment demand for foreign equities, and the emerging countries would benefit from cheaper USD-denominated raw materials as they grow their economies.

Nevertheless, investors who are wary of further swings in the developing markets can look to targeted strategies that implement quality controls. Specifically, Joe Hohn, Portfolio Manager for Dimensional Fund Advisors, pointed out that they look to factors that drive expected returns, such as market equity, small-cap company size, value relative price and profitability.

“Academic research has shown that stocks characterized by smaller capitalizations, lower valuations, and higher profitability have delivered higher expected returns over time,” Hohn said.