VWO - EEM: A Likely Beneficiary After A Credit Event

2023-08-28 09:46:40 ET

Summary

• We focus on the iShares MSCI Emerging Markets ETF as a broad way to trade emerging markets after a risk-off period.
• The iShares MSCI Emerging Markets ETF offers investors exposure to over 800 emerging market stocks and potential long-term growth.
• EEM's top holdings include Taiwan Semiconductor Manufacturing, Tencent Holdings, and Samsung Electronics.

The few emerging economies that have avoided booms and busts have done so by adhering to sound policy frameworks. - Raghuram Rajan

Back in June, I wrote about Emerging Markets making the "greatest comeback since Lazarus" and maintain the belief that this will likely be the big winner after a credit event takes place. Nothing has changed on that view. A dollar surge during a risk-off sequence should then result in a weaker dollar on the inevitable overreaction, which in turn would benefit emerging markets broadly.

Let's focus here on the iShares MSCI Emerging Markets ETF ( EEM ) as a broad way to trade emerging markets after a risk-off period. EEM presents a unique opportunity for investors to gain exposure to large and mid-sized companies in emerging markets. With this ETF, investors can easily access over 800 emerging market stocks and diversify internationally while seeking long-term growth.

EEM's Key Facts

As of June 30, 2023, EEM has net assets of $23,502,695,626 and holds 1,242 different stocks. It has an expense ratio of 0.69%, which includes the management fee, acquired fund fees and expenses, and foreign taxes and other expenses. The fund's 30-day SEC Yield is 2.16%.

EEM’s Top Holdings

EEM’s top holdings constitute a significant portion of the fund’s total assets. The top ten holdings of the fund as of June 30, 2023, accounted for approximately 23.13% of the total fund. The largest holdings include:

1. Taiwan Semiconductor Manufacturing: 6.76%
2. Tencent Holdings Ltd: 3.90%
3. Samsung Electronics Ltd: 3.88%
4. Alibaba Group Holding Ltd: 2.54%
5. Reliance Industries Ltd: 1.40%
6. Meituan: 1.17%
7. China Construction Bank Corp H: 0.92%
8. Housing Development Finance Corporation: 0.89%
9. ICICI Bank Ltd: 0.87%
10. Infosys Ltd: 0.80%

The relatively heavy exposure to Taiwan Semiconductor does make me a bit nervous. I personally think the market is underestimating the potential for a war between China and Taiwan. This may not be an immediate threat and as such won't impact shorter-term trading, but it's a dynamic worth keeping in the back of your mind.

Top Sectors in EEM

The ETF invests in a variety of sectors, which further diversifies its portfolio. The top sectors in the EEM ETF are:

1. Financials: 21.78%
2. Information Technology: 21.02%
3. Consumer Discretionary: 13.10%
4. Communication: 9.71%
5. Materials: 8.01%
6. Consumer Staples: 6.31%
7. Industrials: 6.30%
8. Energy: 4.98%
9. Health Care: 3.75%
10. Utilities: 2.60%
11. Real Estate: 1.74%
12. Other: 0.71%

The sector breakdown largely explains relative weakness given Financials as a top weight, alongside a lack of "FAANG" type names in the Technology allocation.

Emerging markets have tended to more closely track value style investing which favors Financials over Technology anyway. If we look at the US Financials XLF ETF relative to US Technology XLK, we can see that Financials are indeed showing that they can keep up with Technology on a relative basis, and if anything might be due for relative strength. Any relative strength in Financials in the US has global momentum implications.

Geographic Breakdown of EEM

EEM's holdings are spread across multiple non-US countries. No single country accounts for more than a third of the geographical composition. China and Taiwan together represent just under half of EEM.

EEM Performance

Now here is the harsh reality when it comes to EEM - it's been in a lost decade and then some. If we look at emerging markets relative to the S&P 500 ( SPY ), it's been an incredible bear market...

...until it isn't.

Comparison with Similar ETFs

EEM competes with other similar ETFs in the market, including the Vanguard FTSE Emerging Markets ETF ( VWO ) and the iShares Core MSCI Emerging Markets ETF ( IEMG ). However, EEM stands out for its ticker recognitions and length of time in existence. It's worth nothing that EEM and VWO, the behemoths in the space, track two different emerging market indices. EEM tracks the MSCI Emerging Markets Index while VWO a FTSE Index. VWO does have a lower expense ratio at 0.15%, but net of fees, the two have closely tracked each other on average.

Conclusion

Investing in EEM provides an opportunity for exposure to a diversified portfolio of large- and mid-sized companies in emerging markets. Despite its relatively high expense ratio, EEM serves as a good proxy for investing in emerging economies. Timing is everything, of course, and I suspect this is the one to likely load up on after a credit event.

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