A Tale of Two Emerging-Markets ETFs

This article was published in the October issue of Morningstar ETFInvestor. Download a complimentary copy of Morningstar ETFInvestor by visiting the website.

There is a pair of emerging-markets stock exchange-traded funds that speaks volumes about the dynamism of ETFs as an investment vehicle and the diversity of the investor base that uses them. At face value,

Launched in April 2003, EEM was the first ETF to offer investors direct exposure to emerging-markets stocks, underpinned by the most widely followed index of developing-markets stocks: the MSCI Emerging Markets Index. For years, EEM was ETF investors’ go-to for emerging-markets stock exposure. But success breeds competition. Vanguard debuted the ETF share class of its emerging-markets stock index fund,

VWO was playing from behind, as EEM had already amassed $4.3 billion in assets, but it had an edge: Its 0.30% fee was a fraction of EEM’s 0.77% toll. Between its introduction and October 2012, the Vanguard ETF gathered $55.8 billion in net new flows versus $22.8 billion for EEM. The Vanguard fund’s fee had ratcheted down to 0.22%. EEM’s fee also declined but stood at a still-high 0.68%. And it wasn’t just on the emerging-markets front that BlackRock was losing the battle. One analyst claimed the firm was suffering from a case of “Vanguarditis.”

BlackRock took its medicine, launching its low-cost “Core” series of ETFs, which included IEMG. The fund was designed to go toe-to-toe with Vanguard’s offering. It tracks a slightly broader index, the MSCI Emerging Markets Investable Markets Index, and charged a competitive 0.18% fee. The response was effectively an attempt by BlackRock to have its cake and eat it, too. Rather than slashing the fee on its existing multibillion-dollar fund and forgoing millions in fee revenue, it was splitting its current and prospective clientele in two.

Long-term investors tend to have a strong preference for broad diversification and low fees. Short-term traders command greater liquidity. Within a three-day holding period, they’ll pay a tiny fraction of a fund’s annual fee but absorb the full cost of a round-trip trade. And so, IEMG became the choice of the former cohort, while EEM remained the reserve of the latter. This dichotomy speaks to the variety of different ways ETFs are used and the breadth and depth of the ETF user base, which runs the gamut from individual investors to high-frequency traders. IEMG may be a core portfolio building block for a whole host of long-term investors. EEM may be fodder for fast traders, sold short, and has a robust options chain.

From October 2012 through September 2017, IEMG saw $32.4 billion in net new flows, the Vanguard ETF $3.6 billion, and EEM experienced $1.8 billion in outflows. These numbers seem to indicate that long-term investors 1) are a fee-conscious bunch and 2) aren’t about to allow asset managers to have their cake and eat it.

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