While the universe of smart beta exchange traded funds continues growing, emerging markets stocks are not as represented in this space as are developed markets equivalents. The JPMorgan Diversified Return Emerging Markets Equity ETF (NYSEArca: JPEM) is one way for investors to seek an alternatively-weighted strategy in developing economies.
JPEM selects components based on a diversified set of factor characteristics, such as relative valuation, price momentum and quality. Additionally, securities are diversified across industries. The underlying index may also utilize up to 20% of its assets in exchange traded futures to better track the underlying index.
“According to Morningstar data, the number of smart-beta ETFs with more than half their assets invested in developed countries is 10 times greater than those with a majority invested in emerging ones,” reports Evie Liu for Baron’s. “The gap in assets is even steeper: While the former had attracted more than $2.5 trillion by the end of June, the latter had only $35 billion.”
Through its multi-factor indexing methodology, JPEM could provide better risk-adjusted returns than the broader large-cap benchmark. Specifically, its its enhanced indexing process would allow the ETF to exclude expensive, low quality companies with poor momentum.
Factor Advantages In Emerging Markets
While the population of smart beta emerging markets ETFs remains small relative to developed market equivalents, data suggest factor investing works in developing economies.
“According to 2018 research by the Dutch asset-management firm Robeco, a portfolio favoring value and momentum stocks within the MSCI Emerging Markets Index generated an annualized return of 16.7% from 1988 through 2017, while the broader index returned an average of 11.4%. That five-percentage-points outperformance is even better than that in developed markets,” according to Barron’s.
Factor-based strategies like smart beta ETFs can be used to solve different portfolio needs. For instance, single factors help target exposure to enhance returns or address specific client needs, whereas a multi-factor approach may provide a diversified core equity allocation that leverages the benefits of multiple factors and limit cycle risks associated with individual factors.
“Still, since most quant funds have diversified portfolios, problems with individual stocks tend not to have a significant impact on performance,” reports Barron’s. “The long-term benefits of factor investing remain. As more investors come to understand factors better, emerging markets will likely be the next battleground for smart-beta strategies.”
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