The indexes that underlie the Vanguard and BlackRock ETFs have 32% and 27% exposure, respectively, to Chinese equities, which have been challenged by trade tensions, regulation and a post zero-COVID-19 surprise that never arrived. Since January, the $5.3 billion iShares MSCI Emerging Markets ex China ETF has seen net flows of $2.2 billion, or 42% of its total assets under management, while more than doubling the year-to-date return of the China-inclusive index (5.4% vs. 2.6%) as of Oct. 6, according to research firm CFRA.
But Rich Nuzum, global chief investment strategist at Mercer and executive director, investments, said that the relative value of emerging markets equity is clear. Excluding the Magnificent Seven mega-cap tech stocks, the S&P 500 is valued at roughly 16 times earnings, whereas emerging markets stock are trading at 11 times, Nuzum said. "India, for one, has made it clear that it's open for business and ready to benefit from the China pullback."
Among single-country funds, India ETFs have seen more than $2 billion in net inflows over the past three months. The $479 million iShares MSCI India Small-Cap ETF has returned 23.8% this year through Oct. 6, according to CFRA.
More nuanced broadly based index approaches, as well as active strategies, have also provided outperformance.
The largest active emerging market ETFs are managed by American Century's Avantis Investors and Dimensional Fund Advisors, which both use a more quantitative, whole-market approach. Avantis Emerging Markets Equity ETF has added 34% of its $3.7 billion in assets this year, while Dimensional's Emerging Core Equity Market ETF added 35% of its $2.9 billion in assets and its Emerging Markets Core Equity 2 doubled its assets to $2.2 billion. (Core Equity 2 holds more companies and slightly more exposure to small-cap and value factors.)
With a more values-based strategy, the $605 million Freedom 100 Emerging Markets ETF has added $359 million in assets since January, while returning 4.2%. The ETF tracks an index based on personal and economic freedoms, built off data from Fraser Institute and Cato Institute. The index is rebalanced once a year and currently includes significant exposure to Taiwan, South Korea, Chile and Poland.
Perth Tolle, founder of Life + Liberty Indexes, which publishes the Freedom 100 Emerging Markets index, said she has seen an increase in institutional index data customers throughout 2023 as ETF assets surged. "ETF adoption is the hurdle, not emerging markets or the methodology," said Tolle. "Those licensing the data are building their own strategies off the index."
Another, often critical, factor to emerging markets investments is the treatment of currency fluctuations, which are a function of macroeconomic factors, trade policy, relative interest rates and currency pegs. The 5-year old, actively managed WisdomTree Emerging Markets Multifactor ETF used currency hedges to compel its 11.7% year-to-date return and has doubled assets to $4.6 million.
"So many of our conversations with clients focus on how the funds weight exposure to China," said Jeremy Schwartz, global chief investment officer at WisdomTree, which also has a broad-based ex-China fund as well as several dividend-focused emerging markets ETFs.
But not every ETF with heavy exposure to China has underperformed. The $257 million SPDR S&P Emerging Markets Dividend ETF has delivered an under-the-radar 29% in 2023, garnering only $28 million in net inflows. The ETF has a 31% exposure to Taiwan and a 29% exposure to China, according to State Street Global Advisors.
Mercer's Nuzum sees two major challenges to emerging markets equities on the horizon. The first is the risk that rates in the U.S. "spiral up" as central banks and foreign holders reduce their exposure to Treasuries; the second is reduced economic growth and the inability to apply new fiscal stimulus in the U.S.
"Major emerging markets are still export-led," said Nuzum. "They are geared to global economic strength and external demand matters a lot in these countries."