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This New Emerging Market ETF Avoids State-Owned Firms

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Emerging market investment was dull in 2013 only to see a trend reversal this year in several nations as volatility levels picked up. Overall, broad emerging markets braved the QE shutdown and the potential rate hike in the U.S. plus anemic growth in most developed nations (read: 3 Emerging Market ETFs Off to a Great Start in 2014).

The most popular product in this space ─ Vanguard FTSE Emerging Markets ETF (VWO - Free Report) ─ lost just 4.2% so far this year while some country-specific funds returned impressively. Still, there are some glitches in the emerging markets where state-controlled enterprises (SOE) have proved to be dragging down total returns in these markets.

Per WisdomTree, State-owned enterprises are owned or operated either in part or totally by its government. It has previously been witnessed that too much government inference can end up adversely impacting the company’s operational performance.

For example, Brazilian state-run energy giant Petroleo Brasileiro S.A. or Petrobras (PBR) has been under pressure for quite some time due to state issues. Not only this, but in November, Petrobras’ high-profile officials were alleged to have been involved in a ‘multi-billion dollar laundering and bribery’ scheme at Petrobras. This also put off its earnings till December and had a decidedly negative impact on the stock (read: Watch This Brazilian ETF Following the Petrobras Scandal).

Also, countries like China and Russia with a communist past often still hold immense control over the nations’ largest and most widely traded companies. To close up this loophole from the promising emerging market picture, WisdomTree recently rolled out the Emerging Markets ex-State-Owned Enterprises Fund (XSOE - Free Report) . The product debuted in the market on December 12 (read: 4 Emerging Market ETFs to Consider for Q4).

XSOE in Focus

The new fund looks to track the WisdomTree Emerging Markets ex-State-Owned Enterprises Index meaning that the index excludes companies having state ownership at more than 20% of the market cap. The fund charges investors 58 basis points a year in fees.

In terms of geographic exposure, China (15.7%), South Korea (15.3%) and Taiwan (11.2%) each has a double-digit exposure, while Brazil (9.3%) and India (8.8%) round out the top five. From a sector perspective, the ETF relies heavily on technology (21.7%), Financials (20.4%), Consumer Discretionary (14.4%) and Consumer Staples (10.44%) with double-digit exposure.

From an individual holdings point of view, the ETF holds 389 securities with almost 24.67% allocation to its top 10 holdings. This ensures minimal concentration risks. Among individual holdings, iPATH MSCI India Index ETN, Tencent Holdings Ltd and Samsung Electronics comprise 4.84%, 4.26% and 3.37%, respectively, of total net assets.

How Does it Fit in a Portfolio?

For investors having less faith in the state-owned emerging market companies, but still seeking to tap the region’s growth story, this fund can be a good choice to invest in. According to the issuer, the MSCI emerging market index generated 80% less returns than the U.S. markets over the past five years and this was due to the anemic performance of the SOE.

The issuer noted that conventional emerging market indices normally put one-fourth of the portfolio in state-owned companies and thus seek to offer investors a product free from major downside risks. As such, this might be a good way to access the growing opportunities in the emerging market space. Moreover, the fund is well diversified as far as individual stock, sector and nation exposures are concerned.

ETF Competition

Though the emerging market space is teeming with products, the newly launched ETF should not face any hurdle in amassing assets thanks to its unique exposure. The investment objective of the new entrant is pretty fresh.

Investors should note that the space is being dominated by the $45-billion ETF VWO followed by another emerging market ETF iShares MSCI Emerging Markets Index Fund (EEM) which has amassed about $35 billion in assets.

Though VWO is a cheap ETF, EEM is charging 67 bps in fees. It is therefore clear that XSOE should stand out given its distinctive investment objective, reasonable fees and moderate concentration risks, and especially for those seeking a new way to target the emerging market space.

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