Another Way To Look At Emerging Markets ETFs

A plethora of diversified emerging markets exchange-traded funds are soaring this year, including some smart beta strategies. That includes the FlexShares Morningstar Emerging Markets Factor Tilt Index Fund (NYSE:TLTE), one of the more seasoned alternatives to cap-weighted emerging markets ETFs.

The FlexShares Morningstar Emerging Markets Factor Tilt Index Fund, which is nearly five years old, is up more than 16 percent year to date and resides near all-time highs.

Talking TLTE

TLTE tracks the Morningstar Emerging Markets Factor Tilt Index. In the case of TLTE, the tilt is toward two of the staples of factor-based investing: Value stocks and small caps. Nearly 56 percent of TLTE's holdings are value stocks, but just over 17 percent are growth names, according to issuer data.

With TLTE being a fundamentally-weighted ETF, investors should expect returns that differ significantly from the MSCI Emerging Markets Index. That is good news. Over the past three years, TLTE is u up 7.3 percent, a better than 2-to-1 advantage over the MSCI Emerging Markets Index. Proving it has been the better risk-adjusted bet as well, TLTE's annualized volatility over that stretch has been 260 basis points below that of the MSCI Emerging Markets Index.

For investors looking to make long-term bets on developing economies, research suggests eschewing cap-weighted indexes could prove rewarding.

Strategy: Eschewing Cap-Weighted Indexes

The investor who seeks total equity market exposure via a market-weighted index may actually pay more for each dollar of earnings or equity for growth companies. At the same time, the investor may not be fully compensated for the risks being taken by under-exposure to small cap and value stocks, according to FlexShares.

China, South Korea and Taiwan combine for over 60 percent of TLTE's geographic weight. Brazil and Russia combine for just over 8 percent, a data point that helps explain TLTE's reduced volatility relative to the MSCI index.

TLTE's underlying index measures the performance of stocks located in emerging countries across the world (as defined by Morningstar) with increased exposure to small-capitalization and value stocks. Stocks that are deemed to be small capitalization or small value have an overweighting in the index compared to their weight in a corresponding market-capitalization-weighted index. Likewise, stocks designated as "large" or "growth" stocks have underweighting compared to a standard market-capitalization weighting, according to FlexShares.

Just under 40 percent of TLTE's holdings are large-caps while 39 percent of the ETF's components are small-caps and that does not include a 16.5 percent allocation to mid caps. Even micro caps chime in at 4.6 percent.

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