AVEM - AVEM: Emerging Markets Stepping Up As The United States Continues To Fight Inflation

2023-04-29 08:04:28 ET

Summary

• AVEM consists of stocks within emerging markets located in countries like China, Taiwan, and India.
• Many emerging countries initiated rate-hiking cycles before the United States and therefore may be better positioned for growth in the near future as the United States remains under inflationary pressure.
• China in particular is a rising global power that could have a significant stake in major developments within fields like technology.
• I rate AVEM a Buy, as this ETF could profit in the coming periods from economic growth in countries whose peak inflation may have already passed.

Emerging markets assets may have a silver lining as the United States economy is poised to enter a period of persistent hikes and even a recession before the year ends. Economies within East Asia, India, and South America may have passed peak inflation and could be well-positioned for growth. I believe for these reasons that more U.S. investors may turn to emerging market securities in the near future. Therefore, I give the Avantis Emerging Markets Equity ETF (AVEM) a Buy.

Quality exposure to emerging markets could be hard to attain due to barriers related to foreign languages and other legal hurdles. Such legal hurdles may include different regulatory policies overseas and local partnership requirements for investors. AVEM and similar ETFs may offer a smoother, diversified way to access such exposure.

China is the most represented nation in this ETF, which I think could provide AVEM with positive momentum in the near future. China is well positioned for growth as the country's economy revitalizes following constant COVID lockdown and is also aggressively hopping on potentially profitable trends within the fields of artificial intelligence ((AI)) and robotics . Industries involved in semiconductors, IT, and energy could gain momentum amid ongoing digitization in nations like China and others across East Asia. Specifically, the majority of semiconductor production and development occurs in nations like Taiwan and South Korea , which are both fairly represented in AVEM. In particular, Taiwan Semiconductor ( TSM ) could be a prominent name in future AI growth , and happens to be the top holding in this ETF.

Strategy

AVEM tracks the MSCI EM IMI NR USD Index. The designated index aims to attain long-term capital appreciation by targeting small-cap companies with specific value and profitability characteristics that indicate potential for greater returns. Companies in this index are weighted based on their market capitalization.

The primary value characteristic sought after is a company's adjusted book/price ratio. Furthermore, the primary profitability characteristic is adjusted cash from operations to book value ratio. This manifests in the chart below as this ETF appears to be slightly overweight in value stocks and yield stocks.

The emerging market aspect of each holding is determined by each company's level of association with an emerging country. Locations represented within the MSCI EM IMI NR USD Index include but are not limited to China, Brazil, Chile, India, and Saudi Arabia. Companies' association with an emerging market is assessed by the institution's primary location of revenue generation, headquarters, principle operations, and principle trading market.

Holdings Analysis

This ETF holds companies within an array of sectors. The most represented sectors are technology, financials, and consumer cyclicals, which together account for almost half of the fund's total sector composition.

The top 10 holdings in AVEM comprise 15% of the overall portfolio while the top 25 account for 23%. Given that this ETF consists of over 3300 holdings, AVEM could be considered quite top-heavy. On this same note, individual holdings beyond the top 10 are likely to have virtually no impact on this ETF's overall performance.

Notable Metrics

This ETF has significantly lower expenses than some of its peers, which could make it a more profitable option in the long-term, especially with the potential of currency risk to impact price trajectory. AVEM's expense ratio is less than half of several alternatives that have similar strategies and track records. Some alternatives include the iShares MSCI Emerging Markets ETF ( EEM ) and the iShares MSCI BRIC ETF (BKF).

AVUM's decently high AUM also contributes to its higher liquidity and could also make this ETF relatively more resistant to macroeconomic headwinds.

This aspect could also explain AVUM's relatively lower volatility compared to the S&P.

Volatility is a particularly salient property of assets at the moment as investor sentiment remains somewhat mixed in the United States markets. As seen in the chart below, volatility within the United States has mainly declined since the financial crises in March, but also appears to have popped up recently. On this note, I believe the United States equity market is in for some periods of high volatility while the Fed continues to fight inflation.

AVUM's low volatility could therefore allow investors to dodge headwinds related to economic uncertainty.

Strengths

AVEM provides investors, particularly those within the United States, with potential opportunities for profit and general portfolio enhancement. Emerging market assets may allow investors to hedge high inflation in the U.S. as well as profit from a weakening U.S. Dollar . As seen in the chart below, this ETF has been outperforming the S&P since the beginning of March.

During this same time, recession fears have ramped up within the United States markets as it appears the economy is likely due for more hikes before the Fed gets what it desires. Evidently, AVEM could offer a unique opportunity to profit from non-U.S. endeavors while investor sentiment within the country continues to run wild.

Weaknesses

This ETF's emerging markets aspect opens several doors for profit, but also does the same for risk. Namely, AVEM possesses some unique risks stemming from its diversified international portfolio.

Though portfolio diversification is often a beneficial aspect, exposure to different economies with different currencies may create price fluctuations down the road. This is a result of economic, social, and political headwinds emerging. For example, China's economy has historically been prone to political and social instability whose future perpetuation could cause this ETF's price to oscillate and its volatility to worsen.

Geopolitical tensions between China and other nations such as the United States may create currency risk. Such risks emerge from fluctuations in the Chinese Yuan compared to the U.S. Dollar. Though emerging markets investors could well profit from a weakening U.S. Dollar in the short to medium-term, the tables could just as well flip in the long-term, putting China in the unideal position.

Opportunities

The United States Dollar continuing to weaken could drive up the price of foreign currencies like the Chinese Yuan and the Indian rupee. This could then drive up this ETF's value as well as attract more investors that might become bearish on U.S. securities in the short to medium-term. This could become more of the case than ever as the Fed's plan to stomp out inflation sooner rather than later may involve at least a small recession.

China's restart and lifting of the Zero-COVID policy could bolster economic activity, demand, and tourism, which could drive up the price of this ETF. China also has the second largest economy behind the United States, and could also be at the forefront of technological advancements like AI that could rake in serious profits looking forward.

Threats

The tech race between the United States in China could enhanced the profits of many companies within AVEM, but could also foster geopolitical tensions with the United States. A worsening relationship between these two nations could also increase the incentives of each nation to participate in acts like espionage and cyberattacks . Chinese technology companies like those in AVEM bearing the brunt of a cyberbreach could inhibit technological innovations and ultimately hinder momentum within this ETF. Additionally, these same conditions could prompt trade restrictions and currency fluctuations on both sides, which could make AVEM more volatile in the long term.

Conclusion

Emerging markets growth could drive up the price of this ETF in the medium term as the economic downturn persists in the United States. For this reason, I rate AVEM a Buy. The misaligned inflation levels between the United States and emerging countries has also created an exchange rate that favors non-U.S. assets. Within the next year or so, I think emerging market assets could become a safe haven option for many investors. On this same note, China's economy in particular could well profit in the long-term with its prominent stance in technology and willingness to go all-in on trends like artificial intelligence.

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