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QEM: A Higher Quality Emerging Market ETF?

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Emerging markets have gained immense popularity in recent weeks on cheaper valuations and global political turmoil. Growing middle class population and additional reforms in key emerging markets like China, India, Indonesia, and South Africa are driving up the appeal for emerging stocks.

Further, growth rates in emerging markets are expected to be much stronger than the developed countries. As per the International Monetary Fund (IMF), emerging markets will likely grow 4.6% this year compared with growth of 1.7% for the U.S. and 1.6% for Japan (read: 3 Top Performing Emerging Market ETFs).

However, the latest Fed minutes stoked fears about the possibility of interest rates hike sooner than expected, leading to capital outflows from the emerging nations. Amid such volatility, it would be worthwhile to take a look at high quality emerging market ETFs that could provide a price appreciation opportunity with some downside protection.

Why High Quality ETFs?

High quality ETFs are generally rich on value characteristics as these focus on stocks having high quality scores based on three fundamentals factors – high return on equity, stable year-over-year earnings growth and low financial leverage. This approach seeks investments in safer stocks and reduces volatility when compared to plain vanilla funds.

Further, academic research shows that high quality companies consistently deliver superior risk-adjusted returns than the broader market over the long term. Given these, we have profiled the two quality emerging market ETFs and the difference between the two.

Market Vectors MSCI Emerging Markets Quality ETF ()

This fund debuted in the emerging market space early this year and has attracted $5.7 million in AUM. It has a 50 bps fees per year and trades is a paltry volume of around 1,000 shares, probably ensuring additional cost in the form of a wide bid/ask spread. The product tracks the MSCI Emerging Markets Quality Index and holds 199 stocks in its basket (read: 3 Emerging Market ETFs Hitting 52-Week High amid Instability).

The ETF is slightly tilted toward the top four firms – Tencent Holdings, Taiwan Semiconductor, China Mobile and Samsung Electronics – that collectively make up for around 19% of total assets. Other firms hold less than 2.8% share, suggesting modest diversification across each security. The holding pattern reflects the fund’s focus on Asian countries like China, South Africa, South Korea, Taiwan and India which take the top five country spots.

In terms of sector holdings, information technology dominates the portfolio at 29%, followed by consumer staples (15.4%), telecommunication services (14.8%) and energy (10.9%). The fund has gained 6.5% since the start of the second half.

SPDR MSCI Emerging Markets Quality Mix ETF ((QEMM - Free Report) )

This fund follows the MSCI Emerging Markets Quality Mix Index, holding a large basket of 607 stocks. It has amassed $6.4 million since its debut in early June and charges a low fee of 30 bps per annum. Average daily volume comes at under 1,000 shares, suggesting higher cost beyond the expense ratio (read: Three Quality ETF Launches from State Street).  

Unlike Market Vector product, QEMM provides higher diversification benefits and is well spread out across various components. Each firm holds less than 3% of assets. Further, the top sector – financials – account for 23.6% of assets while information technology (17.6%), energy (11.2%), telecommunication services (11%) and consumer staples (10.3%) make up for a nice mix, suggesting better sector profile than QEM.

The fund nevertheless focuses on Asian countries similar to QEM. The ETF is up 4.1% so far in the second half.

Bottom Line

Though both QEM and QEMM offer quality exposure across a number of sectors in the emerging markets, they do so in slightly different ways with difference in individual holdings and fees. This is especially true as QEMM offers more diversification benefits as it provides a nice balance across number of securities and prevents concentration (see: all Broad Emerging Market ETFs here).

On the other hand, QEM delivered higher returns over the past one and half month and clearly outpaced the gain of 4.9% for the ultra-popular Vanguard FTSE Emerging Markets ETF (VWO - Free Report) . This suggests that investor willing to take a slightly extra risk could go for QEM.

The major difference is also highlighted in the table below:

Fund Inception January 2014 June 2014
AUM (in millions) $5.7 $6.4
Expense Ratio 0.50% 0.30%
Average Daily Volume (as per 1309 822
Total Number of Stocks 199 607
% of Assets in Top 10 Holdings 34.46% 18.25%
2H14 Returns (as of August 20) 6.50% 4.10%

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