Under The Hood: Internally Focused

Not long after investing in emerging markets went mainstream, experts and pundits touted the virtues of tapping into consumers residing in those developing countries. There has been ample talk of the "rise of the middle class" in Brazil and the "newly rich" in China, just to name a couple of examples.

Arguably, investors have been led astray when it comes to tapping into the growth of consumers in developing nations. It may seem like a good idea to own large multi-nationals that have increasing emerging markets exposure, but consumers in these countries still love their local brands. Some ETFs have proven as much.

The newly minted EGShares Emerging Markets Domestic Demand ETF (NYSE:EMDD) is the latest fund to attempt to harness the emerging markets consumer theme. Home to 50 stocks, the EGShares Emerging Markets Domestic Demand debuted on Tuesday and the fund is noticeably different than the popular EGShares Emerging Markets Consumer ETF (NYSE:ECON).

While ECON is more of a consumer discretionary play, EMDD includes five sectors that Emerging Global Advisors believes may be most influenced by organic growth within emerging market economies, according to a statement released by Emerging Global.

No stock accounts for more than 4.9 percent of EMDD's weight while the smallest allocation granted to a single holding is one percent.

At the sector level, EMDD is actually quite conservative. Discretionary names account for 26 percent of the fund's weight, but that is good for just the third-largest sector weight. Telecommunications and consumer staples names combine for 58 percent of EMDD's weight. Utilities and health care round out EMDD's sector allocations with weights of 10.7 percent and 5.2 percent, respectively.

That is not to say EMDD will be a boring ETF. It probably will not be. After all, this is a niche fund focused on emerging markets. In terms of EMDD's country weights, there are multiple perspectives to be considered.

First, investors have every right to be concerned by India's economic struggles and South Africa's high unemployment. Those countries combine for almost 27 percent of EMDD's weight. Second, Southeast Asian economic powers Indonesia, Malaysia, Thailand and the Philippines combine for almost 15 percent of the new ETF's weight. Some might say that is good, others might say it would be better if the ETF increased its allocations to those thriving markets.

Finally, EMDD does deserve high marks for an almost 25 percent allocation to Mexico. Some noteworthy investors have recently extolled the virtues of the Mexican consumer. Should that thesis prove accurate, EMDD would be a winner.

The index EMDD tracks has a trailing price/earnings ratio of 19.2 and price/book ratio of 4.1, implying EMDD is more richly valued than more basic emerging markets ETFs such as the iShares MSCI Emerging Markets Index Fund (NYSE:EEM).

Valuation will not be the sole determinant of EMDD's future success. The thesis here is sound. However, EMDD's returns will be intimately correlated to Mexico's ability to implement legitimate political reform along with India and South Africa's ability to shore up their domestic economies.

For more on emerging markets consumer ETFs, click here.