Strength in the U.S. dollar is hampering myriad assets, including emerging markets equities. Factor-based strategies, including the FlexShares Morningstar Emerging Markets Factor Tilt Index Fund (NYSEArca: TLTE), can provide investors with unique opportunities to buy the dip in developing economies.
The “tilt” in TLTE is away from large-caps and towards higher allocations to mid- and small-caps than are seen in most diversified emerging markets ETFs. That strategy has proven advantageous in years in which state-controlled firms have been laggards.
“We think concerns about a broader problem across emerging markets are overblown,” said FlexShares in a recent research note. “The recent dollar strength (up 2% year-to-date) has been muted compared with the weakness seen in 2017 (down 10%)2 — and we believe the largest emerging markets are in much stronger positions than during the Asian financial crisis of 1997.”
TLTE Holds Over 2,400 Stocks
The $708.3 million TLTE holds over 2,400 stocks, a massive lineup compared to some cap-weighted emerging markets exchange traded funds. Confirming the market cap tilt, over 42% of TLTE’s holdings are classified as small- or micro-cap names. The weighted average market capitalization of the ETF’s holdings is $47.4 billion.
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Even with its significant exposure to smaller stocks, TLTE’s valuations are mostly inline with the MSCI Emerging Markets Index and well below those of major U.S. equity benchmarks.
“We believe emerging market valuations are attractive relative to other markets, as emerging market equities are up just 23% over the last 10 years, compared with a 146% total return from the S&P 500 Index,” said FlexShares. “This leaves the emerging markets index trading at 12 times forward earnings, as compared with 14 times in developed ex-US markets (MSCI Developed ex-U.S. Index) and 17 times in the U.S (S&P 500). We believe this provides some valuation support for emerging market equities. While valuations don’t necessarily help a region’s near term outlook, they may offer support over a longer-term horizon.”
TLTE allocates over 42% of its combined weight to financial services and technology stocks. China, South Korea and Taiwan are the fund’s largest geographic exposures, combining for over 61% of its weight.
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