From the May 2013 issue of Research Magazine • Subscribe!

April 29, 2013

Emerging Markets for Sale

When will emerging market (EM) stocks wake up and join the party?

Although global equity markets in developed countries have risen—and in the United States, have even touched all-time highs, EMs have lagged.

The Vanguard FTSE Emerging Markets ETF (VWO) is down 3% year-to-date versus a gain of 10% of U.S. stocks (VTI) and 5.5% for international stocks (EFA).

The SPDR BRIC ETF (BIK), which tracks the four largest EM countries in the world (Brazil, Russia, India and China) is largely considered a barometer of performance for the category. But like broader emerging market benchmarks, BIK fallen around 3.5% and has struggled to find its footing in 2013.

Could the weakness in EM equities be a buying opportunity? Research from BlackRock argues that investors shouldn’t throw out the baby with the bathwater.

“There are several reasons investors should consider emerging markets for their portfolios including: fast growth, cheap valuations, low inflation and lower relative volatility compared with developed markets. EM stocks are trading at a significant discount of over 20% to developed market equities. In the past, this has represented a good entry point.”

The investment firm also notes that while developed markets struggle with the three Ds of deleveraging, debt and demographics, EM economies are less encumbered by debt, enjoy more sustainable fiscal policies and tend to have more favorable demographics.

VWO, which with almost $60 billion in assets is the largest emerging markets equity ETF, recently changed its index from the MSCI Emerging Markets Index to the FTSE Emerging Markets Index. The key difference between the two indexes is that MSCI includes South Korea, which accounts for about 15% of the MSCI index, whereas FTSE does not.

Morningstar notes: “Since South Korea has a heavy weighting in tech companies, the FTSE index has a lower exposure to technology relative to the MSCI index. However, over the past 10 years, the returns and volatility of the two indexes have been very similar.”

Because MSCI plans on including South Korea in its developed market indexes, that means the country will no longer be part of MSCI emerging market indexes.

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