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In 2017, emerging markets have emerged as the hidden gems in the global investment space. As per a recent report by The Wall Street Journal, developing-world assets have been among the biggest winners so far in 2017. Companies with innovative management and stable business models have led to the recent bull run. This was further fueled by structural change in several emerging nation’s economic policies, sector specific reforms and stock market fundamentals.

The MSCI Emerging Markets Index of stocks gained around 12% this year, more than double the 5.3% gain of the S&P 500. After many years of underperformance, emerging market stocks are shining. We can see signs of improving economic growth in many parts of the developing world. Manufacturing activity is getting into high gear as can be seen from PMI surveys (read:Why Emerging Market ETFs Are Surging This Year).

Low Valuation of Emerging Market Assets

Emerging markets are characterized by growing middle class population, the explosive rise of e-commerce and the expansion of financial services which are still underpenetrated. As per an estimate by Arup Datta, a portfolio manager at AJO, emerging market stocks are currently trading at an average of 12.2x their expected net profits over the next 12 months,much cheaper than U.S. stocks, at 19x.

According to a study by Institute of International Finance (IIF), measured by the P/E ratio, share-market valuations of developing countries are close to their lowest levels while valuations on developed markets are near their highest since 2008. A recent estimate of Research Affiliatesalso indicates the same. The study shows emerging-markets stocks are priced at approximately 14x their average earnings over the past decade, adjusted for inflation. This is just above the low of 13x earnings these stocks hit in 2008. On the other hand, U.S. equities are currently at 29x their inflation-adjusted long-term historical earnings.

Rising Commodity Prices

Several emerging markets with significant commodity exposure have been benefiting from rising commodity prices supported by easy monetary policies, surge in demand and a reduction in supply glut. Most of the emerging markets are commodity-centric. While the commodity market has seen enough of bear days, 2017 has turned a new leaf for it.The prices of commodities like metals and sugar have risen and oil has stabilized at around $50 a barrel. Big commodity producers like Russia and Brazil are benefiting from this scenario. Stabilization of commodity prices has helped reignite investor faith in emerging markets.

Strong Growth Potential

The start of 2017 was dominated by developing economies. If the entire bloc saw the best start to a year since 2012, its largest economy – China – has experienced the strongest start since 2006. The country’s stocks rallied on a series of positive developments, starting from the 6.8% GDP hike in the fourth quarter of 2016, surpassing expectations of 6.7%. This marked the highest clip of expansion since the fourth quarter of 2015.The country's official March manufacturing Purchasing Managers' Index (PMI) increased to 51.8 in March 2017, compared to February's 51.6. This gives cues of stabilization in the economy (read:What Led China ETFs to Outperform in Q1 2017?).

Likewise,India came up with upbeat GDP growth data of 7% in the October–December 2016 quarter despite demonetarization which led many to downgrade the outlook on the economy. The numbers breezed past economists’ expectations of 6.4%. This should spur investors’ optimism around Indian stocks as capitalization boosts the domestic economy (read:5 Reasons to Buy India ETFs Now).

Moreover,Brazil and Russia are emerging out of severe recession. Inflation in these countries is now receding.Even South Korea stocks have been surging despite political turmoil in the country.

Policy Reforms

To boost growth, several emerging economies have been resorting to policy easing via interest rate cuts or offering some accommodative measures. Among the set, China, India, Turkey, Russia and Indonesia deserve a mention. Many of the emerging economies are enacting pro-growth reforms as well. So, higher growth rates should offer investors both capital gains and solid yields.

The government of India recently completed demonetization of higher denominationbanknotes in circulation, as part of a crackdown on illegal money. The Parliament has passed the Goods and Services Tax (GST) bill, a uniform tax structure policy. Moreover, the government plans to boost infrastructure and open up industries such as railways and defense to foreign investment.

Similarly, in mid-March, China’s central bank hiked borrowing costs, again hinting at economic stability. Stabilization in the economy, rise in inflation, decline in real lending costs and a boom in the housing market prompted the central bank to tighten the policy. This in turn is likely to benefit the country’s financial sector.

In addition, the new government South Korea is likely toinitiate some sweeping reforms, particularly in the area of corporate governance.

Risk Diversification

Emerging market equity ETFs provide portfolio diversification, because their returns are not closely correlated to traditional asset classes. Investors who are looking to offset the currency risk are likely to consider emerging market bonds issued in local currencies as a valuable hedging tool.

The economy is expected to improve for several emerging nations, supported by an easy monetary policy adopted by the central banks. Many central banks are cutting interest rates amid lower inflation. Emerging markets debt-to-GDP ratios remain well below that of developed markets. At present, emerging markets are well positioned to attract global investors’ attention by offering high yields with solid macroeconomic fundamentals (read:5 Reasons Why Emerging Market ETFs Will March Higher).

ETFs in Focus

Below we highlight a few emerging markets ETFs that have performed well on a year-to-date basis (as of April 07, 2017).

iShares MSCI Emerging Markets ETF(EEM) : This ETF replicates the price and yield performance of JP MORGAN GBI-EMG CORE INDEX.  The fund manages an asset size of nearly $29,750.36 million and an average daily trading volume of 58,626,837 shares. The fund charges an expense ratio of 72 basis points (bps) a year. EEM is up 12.00% so far this year.

iShares Core MSCI Emerging Markets ETF(IEMG - Free Report) : This fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI Emerging Markets Investable Market Index. The fund manages assets worth $27,084.06 million and an average daily trading volume of 7,769,668 shares. The fund charges an expense ratio of 14 bps a year. IEMG has rallied 12.20% year to date.

iShares MSCI Emerging Markets Asia ETF(EEMA - Free Report) : This ETF seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI Emerging Markets Asia Index. The fund manages an asset size of nearly $314.27 million and an average daily trading volume of 45,271 shares. It charges an expense ratio of 49 bps a year. EEMA is up 14.44% so far this year.

Vanguard FTSE Emerging Markets ETF(VWO - Free Report) : ThisETF seeks to track the performance of The FTSE Emerging Markets All Cap China A Inclusion Index. The FTSE Emerging Markets All Cap China A Inclusion Index, is a market-cap weighted benchmark representing the performance of large, mid, and small-cap companies in emerging markets. The fund manages assets worth $52,171.10 million with an average daily trading volume of 13,901,458 shares. The fund charges an expense ratio of 14 bps a year. VWO has rallied 11.37% year to date.

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