Emerging market equities have witnessed horrendous trading lately ravaged by the economic turmoil in China – the world’s second-largest economy and the largest emerging economy too. Back-to-back blows from China including currency devaluation, lackluster manufacturing data and the failure of the government’s relentless efforts to contain the stock market slide sent shockwaves around the world with emerging markets being among the most vulnerable spots.
This, along with the constant guesswork on the Fed’s lift-off issues, threatened investors about their holdings on this susceptible-but-relatively-high-growth region. Investors ruthlessly dumped emerging market equities in apprehension of an imminent slowdown and a cease in cheap dollar inflows (once the Fed hikes rates). If this was not enough, IMF recently slashed the global growth forecasts for 2015 and 2016, mainly addressing the slowdown in emerging markets hurt by slouching commodities.
The health of emerging markets is worsening, with growth expected to slow in 2015 for the fifth straight year. The two pillars of BRIC region – Brazil and Russia – will likely slip into recession this year and in the next. A protracted commodity market rout eclipsed the growth prospect of these two commodity-rich economies. Other key markets were also not out of the woods.
Capital inflows to emerging markets are likely to turn negative this year for the first time since 1988. The fund outflows ($12.4 billion) in Q3 were the highest since the first quarter of 2014 when the emerging market funds bled $12.7 billion in assets. In September, emerging market ETFs witnessed $1.9 billion of extraction. Though bond funds were also unsteady, equities were hit hard (read: ETFs to Watch as Emerging Market Asset Outflow Doubles).
Though the scenario soothed a lot after a somber U.S. job report for September and China was able to put up some decent factory data for the month, things are yet to go a long way. A lot needs to be seen before investors’ confidence over this troubled-but-important zone is restored.
A compelling valuation after a bloodbath may shower gains on emerging market equities ETFs lately, but we are unsure of how long this optimism will continue.
Several Hedge Funds Are Utterly Bearish
As per Bloomberg, Fortress Investment Group LLC indicated that emerging markets are approaching a bear market of a scale seen during the Asian financial crisis of 1997. Credit crunch in these regions will continue till March 2017 going by the past economic cycles, according to Fortress.
Several other hedge funds like Forum Asset Management and Ray Dalio’s Bridgewater Associates have also pointed to the lingering pain. According to the Institute of International Finance, investors will haul out about $540 billion from developing countries this year.
While all are not outright bearish on this region as many see lucrative opportunities following a sell-off, it is wise to practice a defensive approach while playing this over-sensitive arena (read: Playing Emerging Markets? Try the New Ex-China ETF).
Dollar-Denominated Bond – iShares JP Morgan USD Emerging Markets Bond ETF (EMB)
A low-rate environment especially after the weak labor market data which now points to a delayed Fed rate hike (probably early next year) perked up the appeal for high yield instruments. Emerging market bond ETFs are known for smart yields. However, to cash in on this prospect, investors need go for a dollar-denominated bond ETF.
Since dollar has been range-bound lately, local-currency emerging market bond ETFs performed well of late. But this trend is not likely to linger. After all, the U.S. is the lone star in the developed market pack and the Fed will enact a rate hike sooner or later. And when it happens, local currencies bond ETFs will fail (read: Guide to Local Currency Emerging Market Bond ETFs).
Keeping these factors in mind, we suggest EMB as a good pick. The fund manages an asset base of over $4.4 billion, while charging investors 40 basis points as fees. The fund holds 294 U.S. dollar-denominated government bonds issued by 28 emerging market countries. The fund has lost 1.5% so far this year when the largest emerging market equities ETF (VWO - Free Report) is down over 10%. The fund has a 30 Day SEC yield of 5.33% (as of October 7, 2015).
High Yield – Emerging Markets Equity Income Fund (DEM)
As foreign investors normally park their money in the riskier emerging market bloc for higher yields, what could be a better choice than DEM? This $1.6 billion-ETF holds about 300 stocks. Though the fund is heavy on trouble zones like China, Russia and Brazil, and might see a sell-off ahead, an annual yield of 5.31% would provide some protection against capital erosion. The fund has a Zacks ETF Rank #3 (Hold) and is down 13.2% this year.
Low Volatility – iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV)
A low volatile portfolio is yet another key to long-term success. For investors seeking exposure to the emerging markets, EEMV could be an intriguing pick. The $2.6 billion-ETF charges 25 bps in fees (read: 5 Low Risk ETFs to Protect Returns Amid Volatility).
In total, the fund holds over 250 stocks in its basket with each accounting for less than 1.61% share. The fund has a slight tilt toward financials with 28.7% share, while consumer staples, telecommunication services and information technology round off the next three spots. The fund has retreated 6.2% in the year-to-date frame (as of October 8, 2015) and has a Zacks ETF Rank #3.
High Quality – SPDR MSCI Emerging Markets Quality Mix ETF (QEMM)
High quality ETFs are generally rich on value characteristics as these focus on stocks having high quality scores based on three fundamentals factors – the performance of value, low volatility and quality factor strategies.
This fund follows the MSCI Emerging Markets Quality Mix Index, holding a large basket of 729 stocks. It has amassed about $79 million and charges a low fee of 30 bps per annum. The fund puts more weight in China, South Korea, Taiwan and India. The Zacks Rank #3 fund is off 7.4% year to date and yields about 2.68% (as of October 8, 2015).
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