Is it time to reconsider emerging-market ETFs?

When Emerging Global Advisors (EGA) introduced its first ETF back in 2009 it began with the simple premise that most investors were overlooking the benefits of owning securities in developing markets. Since then, the New York-based firm has reaffirmed that message by adding more ETFs or “EGShares” with distinctive slices of the emerging markets universe, including sector funds.

EGShares includes a suite of nine emerging markets equity ETFs that track custom-designed indices:

  • Beyond BRICs (BBRC)

  • Emerging Markets Core (EMCR)

  • EM Core ex-China (XCEM)

  • India Consumer (INCO)

  • EM Quality Dividend (HILO)

  • India Infrastructure (INXX)

  • EM Strategic Opportunities (EMSO)

  • India Small Cap (SCIN)

  • Emerging Markets Consumer (ECON)

With almost $1 billion under management, EGA’s unique approach hasn’t gone unnoticed. In May, Columbia Threadneedle Investments (the asset management arm of Ameriprise Financial) announced it would be acquiring EGA.

Although emerging market stocks have underperformed over the past several years compared to stocks from developing nations, there are still big opportunities abroad.

Research magazine visits with Marc Zeitoun, chief product and marketing officer at Emerging Global Advisors to get his insight on the state of emerging markets along with the ETF marketplace.

The announced acquisition of Emerging Global Advisors (EGA) will get Columbia Threadneedle (CTI) a foothold into the fast growing U.S. ETF marketplace. How does EGA’s ETF lineup complement CTI’s actively managed funds?

We are excited about joining Columbia Threadneedle Investments and building on our complementary strengths to deliver smart beta strategies across asset classes to investors. This acquisition is an important step in offering investors greater choice in how they access and pay for risk and return. Common investor needs, such as easing volatility and maximizing after-tax returns can effectively be addressed through a combination of active and passive solutions; that’s what makes smart beta increasingly appealing to advisors.

 

Unlike mutual funds, ETFs have intraday liquidity. Do you think this ETF product feature undermines their role as long-term investment vehicles?

Not at all. Smart beta ETFs provide an attractive combination of versatility, transparency and cost-efficiency, with access to virtually every corner of the market. These features appeal to investors looking for a strategic, long-term holding or a specific exposure. In our experience, most clients invest in our funds to access the long-term growth opportunity within emerging markets and tend to hold our funds for multi-year periods.

Emerging market stocks have lagged developed markets over the past several years. Should investors be overweighting emerging markets?

Yes, now is an opportune time for investors to consider increasing allocations in emerging markets because of the asset class’s growth prospects. Over the long term, emerging markets are poised for growth for three main reasons. First, the IMF has recently released its forecast for GDP growth of developed economies versus EM and the differential is getting more and more in the favor of EM. When that has happened historically, emerging markets have outperformed developed markets. Second, emerging markets valuations are now compelling. And third, many emerging market economies have reform agendas and fiscal levers that they can pull to help manage their economies.

So-called “smart beta” investments have both passive and actively managed characteristics. Where do these types of investments fit into an investor’s portfolio?

That’s what makes rules-based strategies so attractive; like active managers, they often express a research element/thesis, but then they have the relative cost efficiency of traditional passive products. We believe investors should implement smart beta strategies as they would any active solution — based on their intended goal or objective. Whether defined by a regional exposure, or by a series of discrete factors such as company profitability and dividend yield, smart beta funds give investors the flexibility to fine tune their portfolio construction process. These strategies work well as core exposures, as complements to active mandates, or satellites to broad passive benchmarks. In fact, we often find ourselves helping advisors build such differentiating portfolios.

Fees in the asset management business have been compressing. Do you think putting active management inside an ETF wrapper is the next big development?

Active ETFs are not a new development; they just haven’t been widely received beyond a handful of products. There will likely be a continued effort to market more of them over time. That said, we believe smart beta in all types of wrappers — ETFs, mutual funds, SMAs, etc. — is more likely to be the next big development.

ETFs still have very low penetration in the retirement marketplace. Do you envision a day when ETFs will become more widely available inside 401(k) plans?

Absolutely. Investors clearly value the versatility, transparency and cost efficiency of the ETF wrapper and once the infrastructural work is universally performed to accommodate them, we will likely see an increase in ETF use in defined contribution plans. In the interim, however, we believe that smart beta strategies offered through mutual funds and other commingled retirement vehicles could satisfy growing investor interest.

What do you see ahead for the ETF industry?

There are no crystal balls, but we do note two areas of growing interest. First, at the product level, we’re going to see a continued proliferation of distinctive smart beta strategies. With common client needs such as volatility management, steady income, and after-tax returns, asset managers will be encouraged to develop targeted products that try to tap into a spectrum of outcomes or of investment themes. It’s an exciting time for product development.

Second, as a result of this greater product palette, we also note a growing opportunity for those who assemble them. The ETF strategist landscape has undergone some important roster changes during the last year and we believe that client demand remains high. Managers who have developed competitive outcome-oriented portfolios to address client investment objectives (beyond simple risk tolerances) will have a differentiated opening in the market. The increasing proliferation of smart beta funds will contribute to this trend and ETF strategists will be better equipped to create more distinctive investment solutions. In the end, better portfolio construction means an improved client experience — and that’s the most important outcome of all.