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ETF Specialist

Look for Consumer Sector Exposure When Selecting an Emerging-Markets Fund

Cap-weighted index funds have somewhat of a global cyclical tilt, as well as exposure to some near-term risks.

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Many investors are aware that  Vanguard MSCI Emerging Markets ETF (VWO) and  iShares MSCI Emerging Markets Index (EEM) (which both track the cap-weighted MSCI Emerging Markets Index) may not be the best vehicles to gain access to the most attractive growth trend in the emerging markets--a rapidly expanding middle class and rising disposable incomes. For example, South Korean and Taiwanese companies, which make up 15% and 11% of the MSCI Emerging Markets Index, respectively, tend to be exporters with significant exposure to North America and Europe. In China (18% of the index), Brazil (14%), and Russia (6%), many of the largest companies tend to be government-owned entities, which, at times, may have to put political interests ahead of profitability. We also note that Indian (6%) and Russian stocks tend to have low floats and not a lot of domestic liquidity, so large foreign fund flows in and out of these stocks further amplifies these markets' high volatility.

Near-Term Concerns
The MSCI Emerging Markets Index is also exposed to a number of current issues that concern us. About 20% of the index's China exposure is in four state-run banks. In 2011, the performance of these banks was weighed by concerns about the quality of their balance sheets, as they were the largest lenders to support the infrastructure stimulus spending in 2009. But a more significant and longer-term headwind could be the government's plan to break up what it calls "the monopoly of national banks" and allow for more competition in an effort to address the underserved consumers and small- and medium-business sectors.

Patricia Oey does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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