VWO - IEMG: A Decade Of Waiting For The Light To Change

2023-09-06 15:58:47 ET

Summary

• Emerging markets have been disappointing in the past decade, but there is potential for a turnaround due to cheap valuations and underinvestment.
• iShares Core MSCI Emerging Markets ETF is a good option for investors looking to diversify internationally, with its broad range of emerging market companies and low cost.
• The IEMG ETF has a lower expense ratio, tracks large, mid, and small-cap companies, and has a higher ESG score compared to its peers, making it stand out among other emerging market ETFs.

Life is like riding a bicycle. To keep your balance, you must keep moving. - Albert Einstein.

No area of the investment universe has been more disappointing than emerging markets. I know this first hand as one of my own strategies was designed to trade relative momentum outside the U.S. equity markets and over the last decade, it's been a story of nothing but false positives and failed leadership. I do believe in cycles and mean reversion, and with 7 years of famine tends to come 7 years of feast (or so I hope). With that said, I think there is a case to be made for emerging markets broadly given cheap valuations, underinvestment, and a potential end to U.S. large-cap dominance.

One way to play emerging markets is through exchange-traded funds, or ETFs. The iShares Core MSCI Emerging Markets ETF ( IEMG ) stands out due to its unique composition. IEMG is an ETF that aims to track the investment results of an index composed of large-, mid-, and small-capitalization emerging market equities. With its broad range of emerging market companies, low cost, and the potential for long-term growth, it makes for an ideal core for a portfolio to diversify internationally.

Fund Characteristics

IEMG has a Beta of 0.66 against the S&P 500 (SP500) over three years, indicating that the security tends to be less volatile than the market. This of course is one of the problem with metrics like Beta, because the fund has not performed anywhere near like 2/3rds of the S&P 500 in the last 10 years. The fund's standard deviation over three years is 18.03%, suggesting a relatively high degree of price volatility. Its Price-to-Earnings (P/E) ratio stands at 11.74, while its Price-to-Book (P/B) ratio is at 1.66, which may suggest that the fund's holdings are undervalued.

As of September 2023, IEMG had net assets of approximately $71.12 billion, with 2,722 number of holdings. The fund's expense ratio is a low 0.09%, making it a cost-effective choice for investors. The 30-day SEC Yield for the fund is 2.77%.

This is a big fund that has frustrated big money. Since inception, the fund has barely performed with annualized returns of 2.48%.

Emerging Markets: A Promising Investment Avenue

Emerging markets provide a unique investment opportunity due to their rapid growth and development potential. They include countries like China, India, Brazil, and South Korea, amongst others.

Investing in emerging markets can offer several benefits. First, these markets often exhibit higher growth rates compared to developed markets, providing a good opportunity for capital appreciation. Second, they offer diversification benefits as these markets tend to be less correlated with developed markets. Finally, they offer the potential for higher returns, albeit at a higher risk.

The fund's sector allocation as of September 2023 was led by Information Technology at 20.50%, followed by Financials at 20.30%, and Consumer Discretionary at 12.80%. Communication stood at 8.97%, while Materials and Industrials accounted for 8.82% and 7.71% respectively. The remaining sectors, including Consumer Staples, Energy, Health Care, Utilities, and Real Estate, made up the rest of the portfolio.

This is the fundamental crux of the issue - the lack of large-cap tech names like what we have in the U.S. that have captured investor attention. The lower weighting to Technology against the S&P 500, and Financials exposure in IEMG have been major hindrances. This, combined with exposure to China which has been challenged for some time, explains the weakness we've seen. If you are bearish on U.S. tech on a relative basis for the next several years as I am, that oddly enough might be IEMG's strongest catalyst for a cycle shift.

Comparing IEMG with Peer ETFs

IEMG is not the only way to gain exposure to emerging markets. There are several other funds with similar investment objectives, including the iShares MSCI Emerging Markets ETF ( EEM ) and the Vanguard FTSE Emerging Markets ETF ( VWO ). However, when compared with these peers, IEMG stands out in several aspects. First, IEMG has a lower expense ratio compared to EEM, making it a more cost-effective choice for investors. Second, while EEM only tracks large and mid-cap companies, IEMG tracks large, mid, and small-cap companies, providing a more comprehensive exposure to emerging markets. Third, IEMG has a higher ESG score compared to its peers, indicating its better positioning in terms of environmental, social, and governance factors.

Conclusion: The Case for Emerging Markets

The iShares Core MSCI Emerging Markets ETF presents a compelling investment opportunity for those seeking exposure to the growth potential of emerging markets given valuations cited and the fact that it's done so poorly for so long, making it due for an area to attract investment flows. With its broad range of holdings, and low cost, it is well-positioned to capitalize on the projected growth of emerging economies.

In the end, the decision to invest in IEMG, like any investment decision, is about where we are in the cycle. U.S. markets continue to dominate. But conditions do change, and if a credit event is out there, this is one to consider allocating to after a major dislocation in risk assets takes place.

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