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Sep 1, 2023

Insights From ETFs: Revisiting Emerging Markets: Opportunities and Risks in the Post-Pandemic World

by Barkha Rani

Emerging markets have long been a topic of interest for investors seeking higher growth opportunities and diversification in their portfolios. These economies often are characterized by rapid development, expanding middle-class populations, and, sometimes, regulatory limitlessness. In the aftermath of the COVID-19 pandemic, global dynamics have shifted, presenting new opportunities and risks for investors in emerging markets. In this article, we will explore the current start of emerging markets, their growth prospects, characteristics of the market and Exchange-Traded Funds (ETFs) to consider for this space.

The New Normal for Emerging Markets

During and post-pandemic, emerging markets pose unique challenges and opportunities. In many cases, these economies have demonstrated remarkable resilience and adaptability, navigating the pandemic-induced economic disruptions more effectively than anticipated. While some sectors, such as technology and e-commerce, thrive during lockdowns, others, like tourism and hospitality, faced severe setbacks.

Economic Recovery and Growth Prospects

The post-pandemic recovery has been a mixed bag for emerging markets. While some countries experienced a sharp rebound due to robust government stimulus and demand for commodities, others faced lingering challenges like mounting debt and slow vaccination rates. For investors, understanding the specific growth prospects and economic policies of individual emerging market economies is essential to identify promising investment opportunities.

Currency and Geopolitical Risks

Investing in emerging markets comes with inherent risks, including currency volatility and geopolitical uncertainties. Fluctuations in exchange rates can significantly impact returns for foreign investors. Additionally, political instability or conflicts can disrupt economic activities and negatively affect investments. Investors must carefully assess and diversify their portfolios to mitigate these risks.

Following are a few of the ETF options we think investors can consider:

Vanguard FTSE Emerging Markets All Cap Index ETF (VEE)

This ETF tracks the FTSE Emerging Markets All Cap China A Inclusion Index. It invests primarily directly or indirectly in large-, mid- and small-capitalization stocks of companies located in emerging markets. The fund holds nearly 5,729 stocks from 28 emerging market countries with the top five regions being China at 32%, Taiwan at 18.4%, India at 18.1%, Brazil at 6.6%, and Saudi Arabia at 4.5%. 

By market-cap, nearly 57% of the total exposure comes from large-cap, 23% from mid-cap, and the remainder from small-cap. While the ETF offers exposure across all sectors, the top exposures are currently reserved for Technology 23%, Financials 21%, and Consumer Discretionary 13%. The top three holdings are no surprise, with Taiwan Semiconductor Manufacturing at 5.2%, the world’s largest independent semiconductor foundry, which is a factory for semiconductor fabrication. Tencent Holdings at 3.6%, is one of the highest-grossing multimedia companies in the world based on revenue and operates and owns WeChat and Riot Games. Alibaba Group at 2.4% is China’s largest e-commerce company and is often referred to as the “Chinese Amazon”. 

The fund manages nearly $1.7 billion in assets while charging a Management Expense Ratio (MER) of 0.24%. The distribution is paid quarterly with an annual yield of 3.0%. VEE has returned 5.8% so far this year.

iShares MSCI Emerging Markets Index ETF (XEM)

XEM replicates the performance of the MSCI Emerging Markets Index, which captures large and mid-cap representation across 24 emerging markets countries. The index, with nearly 1425 constituents, covers approximately 85% of the free float-adjusted market capitalization in each country. It defines emerging market countries as those that are open and accessible to foreign investors, are not generally considered as part of the developed markets universe, and do not belong to countries undergoing a period of extreme economic (for example, hyperinflation) or political instability (example: civil war).  

This ETF holds its U.S.-listed alternative EEM and allows Canadian investors to participate in the index. XEM is not Canadian dollar hedged. XEM’s top regional exposures are China 30%, Taiwan 15%, India 14%, South Korea 12%, and Brazil 6%. The top three holdings include Taiwan Semiconductor Manufacturing at 6%, Tencent Holdings at 4%, and Samsung Electronics at 4%, a South Korean multinational corporation which is the world’s largest manufacturer of mobile phones and smartphones and semiconductor memory manufacturer. Alibaba Group and Reliance Industries come in next, rounding out the top five holdings. 

The top three sector exposures are Financials 22%, Technology 20%, and Consumer Discretionary 14% . The fund is much smaller than VEE and manages nearly $255 million in assets while charging an MER of 0.81%. The trailing yield stands at 1.9% with semi-annual distribution. Year-to-date, the fund has returned 6.5%.

BMO MSCI Emerging Markets Index ETF (ZEM)

ZEM also tracks the MSCI Emerging Markets Index, with the difference from XEM that it directly owns most of the holdings, making it slightly more tax-efficient for some registered accounts. The fund also holds exposure to the iShares MSCI Emerging Markets ETF EEM listed on the U.S. markets but at a much lower weight. EEM is held at a 6% weight at ZEM. Apart from EEM, the top three company exposures include Taiwan Semiconductor Manufacturing at 6%, Samsung Electronics at 4%, and Tencent Holdings at 4%. Alibaba Group and Reliance Industries round out the top five holdings. 

By sector, the largest exposures come from Financials at 18%, Industrials at 16%, and Healthcare at 14%. The sector exposure differs slightly from that of XEM. The top five country exposures are China 28%, Taiwan 16%, India 13%, South Korea 12%, and Brazil 5%. 

The fund manages about $1.4 billion in assets and charges an MER of 0.28%, much lower than XEM. The annual distribution yield currently stands at 2.75%, with an annual distribution. So far this year, the fund has returned 6.3%.

Investing in emerging markets can offer significant growth potential and diversification benefits to investors. However, it is not without its challenges and risks. As the world navigates the post-pandemic landscape, understanding the evolving dynamics of emerging markets is essential for making informed decisions. By carefully analyzing individual economies, sectoral opportunities, and geopolitical risks, investors can identify ETFs that align with their investment goals and risk tolerance. Combining prudent research with a long-term investment horizon will position investors to capitalize on the exciting opportunities that emerging markets present in the post-pandemic world.

Disclosure: Authors, directors, partners and/or officers of 5i Research have a financial or other interest in XIT and ZRE.