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Emerging Market ETFs--Value Play or Value Trap?

The global markets may be sluggish this year (as of April 22, 2016) as evident from 2.5% gains in the S&P 500-based ETF SPDR S&P 500 (SPY) and about 3.0% gains seen in the all-world ETF iShares MSCI ACWI (ACWI) but emerging markets (EM) do not seem this feeble . The broader EM ETF iShares MSCI Emerging Markets ETF (EEM) has advanced about 7.3% so far this year (as of April 22, 2016).

The issues that came in the path of the EM investing last year seem to have quieted as the frequent U.S. rate hike bets have taken a backseat marring the price of the greenback at the start of 2016.

An unprecedented surge in commodity prices in the wake of a weaker dollar, muted U.S. treasury yields, beefed-up stimulus from the Euro zone and Japan, and signs of stabilization in China (which has so far been hitting headlines for wrong reasons) led EM stocks and ETFs to turn from laggards to leaders.

Investors flocked to this space in search of higher current income as well as capital gains. Plus, a compelling valuation drove the space. Notably, the P/E (ttm) is 12 times for EEM and 18 times for SPY.

Rally too Weak to Sustain?
 
We along with several other research houses like Goldman Sachs believe that this rally is not likely to sustain. As and when the global market steadies, the Fed will look forward to tightening its policy, lending strength to the greenback and once again hurting commodities. China is also miles off the full-fledged recovery. So, the current drivers of the rally look too feeble to push the EM stocks and ETFs further.

To make the picture bleaker, Goldman indicated that the forward earnings per share for the MSCI Emerging Markets index are less likely to improve in the near term. The research house mentioned that barring Energy and Materials, “emerging market earnings per share sentiment (stocks with net upgrades as a share of total) is still at 20-year lows.”

Also, UBS research noted that the average growth rate of the 19 biggest emerging economies is projected to be 1.6% higher than that of developed economies. This figure is against the premium of 7.5% seen in 2009, as per UBS. Further, as per Morgan Stanley, EM earnings are likely to plunge 7% in 2016, representing the ‘fifth year in recession’.

All these point to the fact that much of the rally lacks potential.  While Brazil is surging mainly on hopes of a political change despite a sagging economy, Russia is on a tear thanks to oil price recovery. South Africa is also gaining traction on a surge in the metal and mining sector.  But most of these factors look transitory (read: 5 ETFs to Buy if Oil Stays at $40).

To Sum Up

All in all, the operating backdrop is not all bright. So, investors should practice caution while targeting this investing arena or have a high risk appetite to be bullish on the EM ETFs at the current level.

Below we highlight a few ETFs that can be considered in the days to come (see all emerging market ETFs here).

Low Volatility
 
A low volatile portfolio is a key to shield the downside risks. For investors seeking exposure to the emerging markets with lesser volatility, iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV) could be an intriguing pick (read: Minimum Volatility ETFs: Fact or Over-estimated Hype?).
 
High Quality
 
High quality ETFs are generally rich on value characteristics as these focus on stocks having high quality scores based on three fundamentals factors – the performance of value, low volatility and quality factor strategies. There are two choices for this segment; these are EGShares EM Quality Dividend ETF (HILO) SPDR MSCI Emerging Markets Quality Mix ETF (QEMM) (read: 4 Excellent Dividend ETFs for Income and Stability).
 
HILO considers stocks that boast relatively higher dividend yield and three-year dividend payment consistency. On the other hand, QEMM targets EM stocks and looks to provide the performance of value, low volatility, and quality factor strategies.
 
Dividend Yield

As foreign investors normally park their money in the riskier emerging market bloc for higher yields, a high yield ETF could come to investors rescue in difficult times. Thus investors can tap iShares Emerging Markets Dividend ETF (DVYE). Its underlying companies have provided relatively high dividend yields on a consistent basis over time.  DVYE yields about 5.37% annually (as of April 22, 2016).



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SPDR-SP 500 TR (SPY): ETF Research Reports
 
ISHRS-MSCI ACWI (ACWI): ETF Research Reports
 
ISHARS-EMG MKT (EEM): ETF Research Reports
 
ISHARS-MS EMMV (EEMV): ETF Research Reports
 
EGS-LO VT EM DV (HILO): ETF Research Reports
 
SPDR-EM QM (QEMM): ETF Research Reports
 
ISHARS-EM DIV (DVYE): ETF Research Reports
 
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