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Another Active Disappointment And A Cure

ETF Professor

Some asset classes, the ones believed to be vulnerable to periodic spells of inefficiency, including small-cap stocks and junk bonds, are believed to be fertile ground for active managers. Count emerging markets equities among that group.

But as is the case with scores of other asset classes active management is supposed to thrive in, it falls short with emerging markets stocks as well. That trend has been on display this year, as passively managed, emerging markets exchange-traded funds such as the WisdomTree Emerging Markets High Dividend Fund (NYSE: DEM) rebound. The resurgence of emerging markets ETFs is casting a pall over active funds.

Investor Reaction

Investors have been responding to this trend. Recent data from Goldman Sachs indicate investors have allocated to $20 billion to actively managed emerging markets since 2003, but for passive funds that number is $110 billion.

“Investors seem to be voting that passive strategies are the preferred asset allocation vehicle. One reason is the long-term performance record of passive strategies. What explains the recent performance edge?” said WisdomTree Research Director Jeremy Schwartz in a recent note.

Citing Goldman data, Schwartz pointed out that many actively managed emerging markets funds have been overweight defensive developing economies such as Mexico and underweight some of the emerging markets that are really driving this year's rebound. Active managers that are overweight Mexico directly wagered that the outcome of the U.S. presidential election would be different as Mexican stocks and the peso consistently displayed inverse correlations to President-elect Donald Trump's poll numbers leading up to Election Day.

A Little More About DEM

DEM, which is up nearly 19 percent this year, has defensive traits of its own with a 25.5 percent allocation to low beta Taiwan. However, the ETF allocates a quarter of its combined weight to higher beta Russia and South Africa, the former of which was perhaps the one ex-US market hoping for a Trump victory. DEM's Russia allocation is historically well in excess of the MSCI Emerging Markets Index's exposure to that country.

Russia, usually one of the least expensive developing markets, contributes to DEM's attractive multiples.

“We’d note that if investors are rotating into emerging markets because of relatively low valuations, WisdomTree’s strategies tend to have more attractive valuation multiples than the MSCI and traditional cap-weighted indexes,” added Schwartz.

It is hard to argue with the results. This year, DEM is topping about nine of every 10 rival funds in its Morningstar peer category. Since the ETF debuted in July 2007, it has beaten more than three-quarters of rival funds in its Morningstar group.

Disclosure: Todd Shriber owns shares of DEM.

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