Super Cheap Emerging Markets ETFs

A familiar battle cry of emerging markets bulls this year has been that many equity markets in the developing world are trading at noticeable discounts.

In some cases, select developing economies are not only trading at sharp discounts to the broader emerging markets universe, but to their long-term averages as well.

As of the end of July, the MSCI Emerging Markets Index traded at 15.6 percent discount to its 10-year average, but investors should examine whether low P/E ratios on emerging markets indices are functions of slack performance or increasing per share earnings.

"Not only are we interested to know which countries and sectors look inexpensive on an absolute basis today, compared to others, we also want to have an indication of how their P/E ratios look compared to their own history," said WisdomTree research analyst Christopher Gannatti in a new note.

Gannatti's research turned up at least one surprise among discounted emerging markets and some usual suspects, too. Among the usual suspects is chronically inexpensive Russia. According to WisdomTree, the MSCI Russia Index had a P/E of 4.6 as of late July compared to a 10-year average of 8.7.

One reason that Russia is inexpensive, even by its own historically low valuations, is the country's heavy exposure to the energy sector. Emerging markets energy stocks, with a cumulative P/E ratio of 6.9 in the MSCI Emerging Markets Index, are that index's least expensive sector. However, as Gannatti notes, Russia has the highest beta (1.31) among the cheap countries in the index and energy has the highest sector beta (1.23).

Investors do not need to make a single-country bet on Russia. The country can be accessed via an array of diversified emerging markets ETFs, but the WisdomTree Emerging Markets Equity Income Fund (NYSE:DEM) and the new WisdomTree Emerging Markets Dividend Growth Fund (NASDAQ:DGRE) stand-out has two ETFs with sizable Russia allocations at 20 percent and 11.7, respectively.

Russia's larger-than-usual presence in emerging markets dividend ETFs is not unusual because the country is making efforts to bolster dividend growth as a way of attracting more foreign investment.

Like Russia, China trades at significant discounts not only to the MSCI Emerging Markets Index, but its 10-year average as well. The MSCI China Index has a P/E of 9.5 compared to 10-year average of 14.4, according to the WisdomTree research. That is the second-largest discount (behind Russia) among the five low P/E countries WisdomTree examined.

Investors have perceived China inexpensive for much of this year, but only recently have those discounts compelled investors to buy Chinese stocks. One reason stocks are cheap is the China MSCI Index's heavy tilt toward financial services names. That sector is trading almost 32 percent below its 10-year average, according to WisdomTree.

At almost 26 percent, financials are the largest sector weight in DEM and China is the ETF's second-largest country weight behind Russia at almost 17 percent.

"Additionally, we conclude that those valuation opportunities may have a higher likelihood of being confined to countries or sectors with higher betaslower beta sectors and countries tend toward the more expensive end of their historical valuation ranges," said Gannatti.

Of the five countries WisdomTree examined, the one with the lowest beta may a surprise to some investors: Turkey. The MSCI Turkey Index, with a beta of 0.97, currently trades at a 16.2 percent discount to its 10-year average.

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Disclosure: Author is long DEM.