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A Defensive ETF Approach to Emerging Markets


Investors who want exposure to emerging markets while avoiding elevated volatility can evaluate low-volatility exchange traded fund options.

For example, the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV) and PowerShares S&P Emerging Markets Low Volatility Portfolio (EEL.V) can provide a more conservative alternative to market capitalization-weighted emerging market ETFs as a way to reduce an investment portfolio’s overall volatility. [Get Defensive with Low Volatility ETFs]

“Low-volatility strategies seek to exploit the observed phenomenon that portfolios with smaller price fluctuations tend to outperform portfolios with larger price fluctuations over the long term,” writes Morningstar analyst Patricia Oey.

For instance, EEMV’s underlying index declined 42% in 2008 during the height of the financial crisis, whereas the MSCI Emerging Markets Index dropped 53%. EEMV’s benchmark index also showed a similarly lower dip in 2011, decreasing 6% compared to the MSCI index’s 18% fall.

The iShares ETF follows the 225 least volatile stocks, or those with minimum variance, from the MSCI Emerging Markets Index. The portfolio is rebalanced in May and November. EEMV has a 0.25% expense ratio. [More Evidence of a Return to Emerging Markets ETFs]

Top sector allocations include financials 26.9%, consumer staples 13.6% telecom services 11.9% information technology 11.2% and utilities 8.6%. Country weights include China 19.1%, Taiwan 16.3%, South Koreae 12.2%, South Africa 9.0% and Malaysia 8.6%.

Compared to the iShares MSCI Emerging Markets ETF (EEM) , which tries to reflect the performance of the MSCI Emerging Markets Index, EEMV overweights consumer staples, utilities and health care – the more obvious defensive sector plays – while underweighting energy and materials.

Looking at country weights, EEMV has a noticeably lower weight in Brazil, Russia and South Korea, compared to EEM. Additionally, the low-volatility ETF leans toward Taiwan, Chile, Philippines and Malaysia.

Alternatively, the PowerShares ETF tracks the 200 least volatile stocks from teh S&P Emerging BMI Plus LargeMid Cap Index over the past 12 months. Holdings are rebalanced and reconstituted quarterly. EELV has a 0.29% expense ratio.

Along with a heavy 31.2% tilt toward financials, EELV includes 11.1% in consumer staples, 9.8% in telecom services, 9.6% in industrials, 9.3% in energy and 8.4% in materials. The fund also has a heavy weight in Taiwan at 26.4% of the portfolio, followed by South Korea 16.6%, Malaysia 15.1%, Brazil 11.2% and South Africa 8.0%. [The Other Side of Volatility ETFs]

While low-volatility ETFs help diminish potential troughs, the funds will also mute potential peaks. Consequently, these low-volatility strategies could underperform traditional market-cap emerging market indices in a bull rally.

The low-volatility emerging market ETFs also don’t hedge their currency exposure, so investors will be exposed to some currency risks.

For more information on the developing economies, visit our emerging markets category.

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own shares of EEM.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.