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Time to Buy Emerging Market ETFs?

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Emerging market ETFs have been lagging their developed counterparts this year and have been among the worst performing products in the first quarter. This is largely due to a slowdown in domestic demand in the key emerging markets, a lingering Eurozone crisis (which can impact exports), and appreciation in the U.S. dollar.

In fact, these ETFs clearly underperformed the broader U.S. market funds like SPDR S&P 500 ETF (SPY) and Dow Jones Industrial Average ETF (DIA - Free Report) , and the world market funds like iShares MSCI World Index Fund (URTH - Free Report) by a wide margin in the quarter. Flows into ETFs offering emerging market exposure have slowed this year.

Notably, this is the first time in more than a decade when emerging countries have underperformed during a global rally (read: A Trio of Top Emerging Market ETFs for 2013).

This is because most of the emerging economies like India, Brazil and China have been struggling to reinvigorate growth. Investors should note that worries on the macroeconomic and political front in India, the property market in China, and persistent inflation and interest rates hike issues in Brazil are keeping the emerging market returns in check.

Additionally, most of these nations are commodity-centric economies that make them highly susceptible to any downtrend in the global economy. Further, currency declines against the greenback have hit hard both equity and debt markets in the emerging economies, adding to woes.

Better Outlook

Despite these weaknesses, emerging markets are expected to grow substantially compared to the developed world. According to the International Monetary Fund (IMF), emerging economies would grow 5.9% in 2013 compared to 1.9% for developed countries and 2% for the U.S.

Also, valuations for emerging market stocks appear cheaper than the U.S. and developed market stocks, suggesting nice entry points. As a result, investors could tap this opportunity in the form of a basket approach with ETFs (read: Emerging Market ETFs to Soar in 2013?).

While there are several ETFs in the emerging market space, we have highlighted three of the most popular funds in the segment, each of which have posted a loss in Q1. However, these funds could fetch healthy returns considering the attractive valuation of their stocks and solid growth projections by the IMF, making any of the following interesting picks for globally-focused investors:

iShares MSCI Emerging Markets ETF (EEM)

One of the most popular ways to follow emerging markets is through EEM, a fund that tracks the MSCI Emerging Market Index, which measures the equity market performance of various emerging markets.

The fund is widely spread across a large basket of 837 securities and puts little in individual stocks, preventing it from heavy concentration. It puts just 15.85% in the top 10 holdings, suggesting minimal company specific risk. Samsung Electronics, Taiwan semiconductor and China Mobile occupy the top three positions in the basket.

From a sector perspective, financials take the top spot with more than one-fourth of the assets, while information technology, energy and materials round out the next three spots in the basket (read: Banking ETFs: Laggards or Leaders?).

The product appears rich with AUM of over $45.5 billion and average daily volume of about 50 million shares. It charges quite a high annual fee of 66 basis points from investors for the diversity in its portfolio.

In terms of individual countries, China enjoys the maximum allocation with a share of 17.46% while South Korea, Brazil and Taiwan also get double-digit allocation with a share of 14.72%, 12.64% and 10.74%, respectively.

Currently, EEM is trading at P/E of 18.36 times and has a Zacks ETF Rank #3 or ‘Hold’ rating.

Vanguard FTSE Emerging Markets ETF (VWO)

VWO is another popular ETF to track the emerging market with the same index. The fund manages an asset base of $58.4 billion and trades at a volume of more than 18 million shares a day.

The product holds a great deal of securities, about 1,060, and has a slight tilt towards one firm – Samsung Electronics – with 4.1% share. It offers a wide diversification across individual holdings as no other firm makes up more than 2% of VWO. The top 10 holdings combine to make up for 17.8% of the assets.

For sectors, financial gets the maximum allocation closely followed by energy, technology and basic materials sectors. Among various nations, China, Brazil, Taiwan and Korea enjoy double-digit allocation in the fund with respective shares of 18.6%, 13.9%, 10.8% and 10.3% (read: Are China ETFs in Trouble?). The fund charges a fee of 18 basis points annually.

Currently, the ETF is trading with a P/E of 13.6 times and has a Zacks Rank #2 or ‘Buy’ rating. This suggests that this product is expected to outperform over the long haul compared to the other funds in the sector.

WisdomTree Emerging Markets Equity Income Fund (DEM)

This fund tracks the WisdomTree Emerging Markets Equity Income Index, which measures the performance of the highest dividend yielding stocks selected from the WisdomTree Emerging Markets Dividend Index (read: 4 Excellent Dividend ETFs for Income and Stability).

With a total of 237 stocks in its basket, the product is widely spread across individual securities with just 32.62% of its assets in top 10 holdings. The top three firms – China Construction Bank, Gazprom and Banco do Brasil – comprise about 17.43% of the combined share in the basket.

The fund is heavy on financials, closely followed by energy, materials and telecommunication services. In terms of country allocations, Taiwan is at the top (19.62%), followed by China (16.26%), Russia (12.59%) and Brazil (12.16%).

The product has amassed over $5.5 billion in AUM and trades in good volume of more than 737,000 shares per day. The ETF charges 63 bps in fees per year from investors.

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