Developing country stocks have rebounded this year, finally beginning to pull ahead of developed markets, with emerging market exchange traded funds that track customized or smart beta indices leading the charge.
A combination of cheap valuations and improved corporate earnings are supporting the rebound in emerging market stocks.
"EM equities have outperformed their developed counterparts in 2016, reversing a five-year run of dramatic underperformance," BlackRock strategists said in a note. "The EM rebound has coincided with a recovery in corporate profitability relative to the developed world."
"Valuations are still cheap, with the EM worldâ€™s price-to-book ratio one standard deviation below its long-term average," the strategists added.
The Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) and iShares MSCI Emerging Markets ETF (NYSEArca: EEM), the two largest emerging market plays, have only generated a 0.7% and 1.8% average annualized return over the past five years, compared to the S&P 500's 13.8% annualized return. However, emerging markets are outperforming in 2016, with EEM and VWO up 15% each year-to-date while the S&P 500 is 3% higher.
Among the best performing emerging market ETFs around, funds that track alternative or factor based indexing methodologies have outperformed, notably those with a greater value tilt.
For starters, the PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca: PXH) is the best performing broad emerging market ETF so far this year, rising 35.0% year-to-date. PXH tracks the FTSE RAFI Emerging Markets Index, a fundamentally-weighted ETF focusing on the virtues of book value, cash flow, sales and dividends.
Due to its indexing methodology, PXH leans toward the value style, with large-cap value making up 48.2% of its underlying holdings. The ETF is also overweight Brazil at 29.9% of its portfolio, followed by China 21.0% and Taiwan 11.3%. PXH still shows an attractive 11.1 P/E and a 1.0 P/B.
The Schwab Fundamental Emerging Markets Large Company ETF (NYSEArca: FNDE) has increased 34% year-to-date. FNDE tracks the Russell Fundamental Emerging Markets large Company Index, which selects, ranks and weights components based on fundamental factors like adjusted sales, retained operating cash flow and dividends plus buybacks.
The Schwab Fundamental Emerging Markets ETF also includes a hefty 55% tilt toward the large-cap value style, with a cheap 10.3 P/E and a 0.9 P/B. FNDE is less top heavy on its country allocations but overweights South Korea at 18.6%, along with Brazil 17.4%, China 15.7% and Russia 12.4%.
Additionally, the Global X SuperDividend Emerging Markets ETF (NYSEArca: SDEM) advanced 22% year-to-date. SDEM includes 50 of the highest dividend yielding equities in the emerging markets. Consequently, the ETF also shows an attractive 5.57% 12-month yield. However, the fund is still rather small with $3.8 million in assets under management and an average daily volume of about 2,000 shares, so potential investors should use limit orders to better control trades.
The Global X option has a large 40% weight in large-cap value and 19% in mid-cap value. It shows a 10.0 P/E and a 1.1 P/B. The country weights more or less follow traditional ratios, with a big China position at 19.3%, followed by Brazil 15.2% and Russia 11.8%.
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