Diversified emerging markets ETFs are supposed to be diversified, but many of these funds feature some concentration risk, particularly at the geographic level.
For example, two of the category’s most popular funds, the iShares Core MSCI Emerging Markets (NYSE:IEMG) and the Vanguard FTSE Emerging Markets (NYSE:VWO) feature significant China exposure. IEMG’s China weight is 28.47%, or more than double the weight assigned to its second-largest geographic weight. As of the end of last year, VWOs China weight was 33.7%, also more than double that of its second-biggest geographic weight.
Geographic concentration risk is one reason why this behemoth Emerging Markets ETFs are not rated higher by some analysts.
“The reason these low-cost options aren’t rated higher is they have large stakes in Chinese stocks, with roughly one-third of their portfolios dedicated to companies listed in China,” said Morningstar in a recent note.
The research firm has Bronze ratings on IEMG and VWO.
What’s Next For The Chinese Market?
“The Bronze rating isn’t a reflection of expectations about the Chinese market. Instead, it shows a lower level of confidence in the ability of these funds to perform well within the category, because they don’t diversify their country-specific risk as well as some of their actively managed competitors,” said Morningstar.
Recent data points indicate traders are buying some marquee ETFs tracking developing economies. After the recent pullback in the equities market, bargain hunters may look to beleaguered emerging market stocks and region-related ETFs for value.
Investors appear to be embracing the ideas that the dollar will weaken this year and that the Federal Reserve will slow its pace of interest rate hikes or that no rate increases at all will be delivered in 2019. However, it is pivotal to the fortunes of funds such as IEMG and VWO that the U.S. and China resolve their trade dispute.
Related: 7 Indicators Reveal Underlying Weakness for China ETFs
While China exposure is a risk to consider with IEMG and VWO, the funds have other benefits, including low fees and solid exposure to other developing economies. According to Morningstar,
Despite a relatively high allocation to Chinese stocks, they still effectively diversify stock-specific risks and charge some of the lowest fees in the category. While Chinese stocks account for roughly a third of these funds, they make up less than 4% of the total global stock market. So these funds can still be a great compliment to a portfolio that invests in stocks from the U.S. and foreign developed markets.
The iShares Core MSCI Emerging Markets ETF (IEMG) was trading at $50.06 per share on Friday afternoon, up $0.35 (+0.70%). Year-to-date, IEMG has declined -12.02%, versus a 0.33% rise in the benchmark S&P 500 index during the same period.
IEMG currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #8 of 93 ETFs in the Emerging Markets Equities ETFs category.