What Large-Cap Emerging Markets ETFs Don't Give You

Scott Burns: Exploring the relationship between emerging market ETFs and their actively managed counterparts.

Hi there. I'm Scott Burns, Morningstar's director of ETF research, coming to you live from Morningstar's premiere ETF Invest Conference.

Joining me today is Van Eck's David Semple, who is the director of International Investment with Van Eck.

David, thanks for joining me.

David Semple: Very welcome.

Burns: So David, we actually have a very unique situation here. You work with a company that I think, by and large, made its name through investing actively. But it's been really one of the leaders and the pioneers, especially in the more niche areas of emerging markets and other outside arenas in the ETF space.

And I was just wondering if you could tell us a little about how Van Eck's ETF business and your actively managed funds at Van Eck, how they work together and what investors can expect from that relationship?

Semple: Well, we really co-exist pretty peacefully. There's no nasty arguments between the active and the passive guys.

Burns: Good to know.

Semple: And we understand that the ETFs provide a function for a lot of investors who don't necessarily want to take our offerings on hard assets or emerging markets, want to play some specific part of what we do. For instance, they want a very liquid play on gold mining shares.

Burns: Right.

Semple: I think it's interesting for us to see how the trading has developed in these places. As we were talking earlier, the percentage of ETF trades in places like Brazil, percentage of trading, as ETFs has gone up very much. So, it has…

Burns: And you know, in that what we are talking about for the viewers is actually the ETFs that are listed in the U.S. and Europe and other places, and what their impact is on the underlying stocks on the Bovespa in Brazil, you know, it could be anywhere from 20% to 40%...

Semple: Absolutely.

Burns: …depending on the day and what's going on.

Semple: Yeah.

Burns: So really you're talking about a handful of Western or developed listed financial products that are really driving the market in some of these emerging markets.

Semple: Yes. And that has interesting implications in terms of liquidity in certain places. It actually increases the liquidity, which makes it easy for us to implement what we think is right on the active side, which is good.

Every now and again people ask the question about active versus passive, and say, what about this ETF and how does that compare to your active fund? And I did one of these recently, and I was, as I have been many times, shocked to see what's under the hood in these ETFs and to see what implicit bets people are taking within those ETFs that they probably don't realize. I mean, the big one is for EEM or the large-cap emerging markets. If you think you're taking a broad view of emerging markets by buying these, sometimes you have to be careful because these things are traded not necessarily for emerging markets reasons, for hedging reasons.

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Burns: Right.

Semple: And then what you get underlying that tends to be big global cyclical because they tend to have the market cap that these guys want to be playing in.

Burns: Right, a lot of telecom, a lot of petroleum.

Semple: Well, a lot of energy, a lot of technology, a lot of materials. And if you look down the cap curve, you're going to get lot more of the domestic demand, the consumer cyclical, there is consumer staples, the industrials that I think people really think they're buying with emerging markets. So you really have to look underneath, I mean, as they perform a useful function, but there is certainly room for a more granular, more involved approach of the active fund manager.

Burns: Especially, if your investment thesis is to play on the growing prosperity of the local people in these emerging markets?

Semple: Yes. And our particular specialty in emerging markets is to look for emerging companies.

Burns: Emerging, emerging.

Semple: Emerging growth companies in emerging markets. And by definition, they are not in your index yet.

Burns: Right.

Semple: Because when they're successful and if we are successful investing with them, they will then – either then go into the index and then go into the ETF, and good luck to you, that's over to you. We may continue to hold them, because a business – good business model is a good business model. But we want to get these guys before they're ETF-ed.

Burns: Right.