For emerging markets, it’s largely been a lost decade. In fact, it’s been even longer than that! Since Halloween 2007, the iShares MSCI Emerging Markets ETF (EEM) has returned a whopping 2%! No, not 2% per year. 2% total. It’s a bit of an arbitrary starting point, but it clearly demonstrates how long it’s been since emerging markets have had their moment in the spotlight. Considering that the S&P 500 has returned roughly 250% over that same time frame, it’s no surprise that some market watchers are saying that emerging markets are poised and long overdue to make a comeback.
From the bottom of the COVID pandemic recession to the end of 2021, the markets didn’t really care about fundamentals. They had 0% interest rates and trillions of dollars of government stimulus in their back pockets. They were willing to swing for the fences with growth and high beta stocks, but even just a straight investment in the S&P 500 yielded 20%+ returns.
2022, however, has been a different story. Fundamentals matter again and investors are paying a lot of attention to value, low volatility, quality and dividend stocks. Emerging markets certainly qualify in that first category and may present some of the best value opportunities in the world right now. P/E ratios of less than 10 and dividend yields north of 7% have become more commonplace in today’s market. We could look back in a few years and recognize this as an excellent entry point.
It’s not a slam dunk though. Central banks are continuing to tighten monetary conditions in response to inflation and most economic growth measures show that we’re likely heading towards recession sometime in the next 12 months. These aren’t typically the conditions that emerging markets perform well in and it’s quite possible that EM equities could head lower before they head higher. Still, valuations are such that there’s a built-in layer of downside protection and much of the worst case scenarios are already priced in.
Ranking The Emerging Markets ETFs
The variety of ETF choices makes distinguishing the best from the rest a little challenging. You’ve probably heard most financial pundits talk about focusing on funds with low expense ratios. That can certainly be a big factor in deciding which ETF to go with (it’s probably the most important factor, in my view), but there are a lot of things that could go into making the right choice.
That’s where I’m going to try to make things easier for you. Using a methodology that I’ve developed, which takes into account many of the factors that should be considered and weighting them according to their perceived level of importance, we can rank the universe of available ETFs in order to help identify the best of the best for your portfolio.
Now, this certainly won’t be a perfect ranking. The data, of course, will be objective, but judging what’s more important is very subjective. I’m simply going off of my years of experience in the ETF space in helping investors craft smart, cost-efficient portfolios.
Methodology & Factors For Ranking ETFs
Before we dive in, let’s establish a few ground rules.
First, all of the data is used is coming from ETF Action. They have gone through the ETF universe to identify and categorize those ETFs used here. There are many that qualify and we’ll be using their categorization as a starting point. Many thanks to them for opening up their vast database for my use.
Second, let’s run down the factors I used in the ranking methodology.
- Expense Ratio – This is perhaps the most important factor since it’s the one thing investors can control. If you choose a fund that charges 0.1% per year over a fund that charges 1%, you’re automatically coming out ahead by 0.9% annually. You can’t control what a fund returns, but you can control what you pay for the portfolio. Lower expense ratios equal more money in your pocket.
- Spreads – This relates to how cheaply you can buy and sell shares. Generally speaking, the larger the fund, the lower the spreads. Bigger funds usually have many buyers and sellers. Therefore, it’s easier to find shares to transact and that makes them cheaper to trade. On the other hand, small funds tend to trade fewer shares and investors often need to pay a premium to buy and sell. Considering expense ratios and spreads together usually give you a better idea of the total cost of ownership.
- Diversification – Generally speaking, the broader a portfolio is, the better chance it has at reducing overall risk. A fund, such as the Energy Select Sector SPDR ETF (XLE), provides a good example. 45% of the fund’s total assets go to just two stocks – ExxonMobil and Chevron. By buying XLE, you’re putting a lot of faith in just those two companies. An equal-weighted fund, such as the Invesco S&P 500 Equal Weight Energy ETF (RYE), would score higher on diversification than XLE.
- FactSet ETF Scores – FactSet calculates its own proprietary ETF ranking for efficiency, tradeability and fit. They basically are designed to tell us if an ETF is doing what it sets out to do. I’m not going to copy and paste that work that they’re doing, but there is some influence there to make sure my rankings are on the right path.
There are a few other minor factors thrown into the mix, but these are the main factors considered.
One thing that is not considered is historical returns. Most ETFs are passively-managed and are simply trying to track an index, not outperform. ETFs shouldn’t be penalized for low returns simply because the index they’re tracking is out of favor at the moment.
I’m ranking ETFs based on more basic structural factors. Are they cheap to own? Are they liquid? Do they minimize trading costs? Do they maintain risk-reducing diversification benefits?
Being in the bottom half of the list doesn’t automatically make a fund “bad”. It simply means that due to a low asset base, a high expense ratio, a concentrated portfolio or some other factor, it poses additional costs or downside risks.
Best Emerging Markets ETF Rankings
The Vanguard FTSE Emerging Markets ETF (VWO) takes the #1 spot in these rankings, but it’s no surprise that the low-cost cream of the crop rises to the top. The four cheapest ETFs in this group – VWO along with the iShares Core MSCI Emerging Markets ETF (IEMG), the SPDR Portfolio Emerging Markets ETF (SPEM) and the Schwab Emerging Markets Equity ETF (SCHE) – represent the biggest heavyweight issuers in the industry. There’s enough of a gap here on expense ratios and liquidity that the top 4 ETFs stand pretty much on a tier to themselves.
There are a few other low cost ETFs on this list worth mentioning. The BNY Mellon Emerging Markets Equity ETF (BKEM) competes right alongside the top 4 with its 0.11% expense ratio, but it just hasn’t built up the asset base yet and that makes liquidity more of a problem. It’s been around for more than two years at this point, so I feel like if it hasn’t done it by now, it might not ever do it.
The Columbia Emerging Markets Core ex-China ETF (XCEM), the iShares ESG Advanced MSCI Emerging Markets ETF (EMXF) and the iShares ESG MSCI Emerging Markets Leaders ETF (LDEM) (along with BKEM) prove how tough it is to compete on cost with the big guys. EMXF and LDEM are more interesting cases. They’ve been around since 2020 and came at a time when the industry anticipated a big boom in socially conscious investing. The ESG ETF theme, however, has turned out to be a bit of a bust. The biggest ETFs will survive, although the beef with them is that they end up looking a whole lot like the broader indices, such as the S&P 500, but just with a much higher price. I don’t see the emerging markets versions of ESG funds ever really taking off, but the low expense ratios certainly give it an advantage with that theme.
The biggest surprise for a lot of investors may be the name that appears at the bottom of this group at #32 – the iShares MSCI Emerging Markets ETF (EEM). It’s still the 3rd largest emerging markets ETF out there, but it’s been eclipsed by the lower cost IEMG as the better choice from iShares. EEM is still favored by the big institutions due to its high liquidity and ultra-low trading costs, but that 0.68% expense ratio isn’t going to do it any favors at all.
Quick shout out to the WisdomTree Emerging Markets ex-State Owned Enterprises ETF (XSOE). Its #10 ranking on this list may not necessarily stand out, but I think this is the one ETF that should be under consideration to replace one of the plain vanilla emerging markets ETFs. Government-controlled businesses tend to be inefficient and have less growth potential because that’s not really what they’re interested in. This tends to act as something of an anchor on long-term return potential. Removing these companies from the mix gives the fund a more pure business-oriented approach and could be a better way to invest in these markets.
The high yields available in emerging markets right now become readily apparent when looking at this section of the rankings. Along with the iShares Emerging Markets Dividend ETF (DVYE), which came in at #23, you’ve got the WisdomTree Emerging Markets High Dividend ETF (DEM) and the Pacer Emerging Markets Cash Cows 100 ETF (ECOW) to consider. All of these currently yield somewhere between 7-10% annually and invest in some of the biggest, most durable and most cash flow heavy names in these regions. The expense ratios are a little on the high side, but current market conditions mean that they offer better shareholder value today than they have in years.
Speaking of ECOW, this is the emerging markets version of its sister fund, which has been a breakout star in 2022 – the Pacer U.S. Cash Cows 100 ETF (COWZ). Both funds focus only on those companies with the highest free cash flow yields (free cash flow is what’s left over after the company has paid all of its bills and reinvested in itself). It’s a good way of investing in high yielding names backed by healthy, strong balance sheets. Its strategy was out of favor when the markets focused on mega-cap growth and tech, but it emerged in a big way last year.
The final group of emerging markets ETFs on this list:
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