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A Hidden Gem Among Emerging Markets ETFs

ETF Professor

Emerging markets stocks and exchange-traded funds are back in style this year, but some ETFs tracking developing economies are going unnoticed. That is particularly true of emerging markets small-cap ETFs.

Perhaps the reason for that is investors often associate smaller stocks with volatility and from there assume that with emerging markets' equities being more volatile than developed market equivalents, then emerging markets' small caps must be exceptionally volatile.

But Wait ...

That is not necessarily the case as the SPDR S&P Emerging Markets Small Cap (ETF) (NYSE: EWX) highlights. Year-to-date, EWX is up 16.5 percent. That puts the ETF ahead of the Russell 2000 by 420 basis points. EWX also easily wins the risk-adjusted battle as its annualized volatility to this point in the year is exactly the same as the Russell 2000's.

Related Link: John Hancock Adds 5 Sector ETFs To Schwab's Commission-Free Platform

EWX also trades at a discount to competing U.S. small-cap benchmarks, underscoring the valuation case for emerging markets stocks.

... There's More

“From a valuation standpoint, few markets are cheap. EM has traded at a material discount to DM in price-to-book value and price-to-earnings ratio for the past few years, and we’ve seen limited gains in relative return on equity (ROE),” said State Street in a recent note. “The main question is whether earnings per share (EPS) and ROE can continue moving in the right direction. There needs to be more confidence that global economic growth will be strong enough to support EPS expansion, and we believe evidence of earnings will be required to extend the rally.”

The $325.1 million EWX, which turned eight years old earlier this year, is Asia-heavy as Taiwan, China and India combine for over 56 percent of the ETF's geographic weight. Six of the ETF's top 10 country allocations are Asian nations. Brazil is the ETF's largest non-Asia exposure at almost 5.4 percent.

What Makes EWX Unique

Unlike large-cap emerging markets ETFs, EWX is neither heavy on state-owned enterprises nor it is excessively allocated to energy and financial services names. Rather, the small-cap ETF is more levered to the emerging markets consumer theme with a combined weight of 38 percent to technology and consumer discretionary stocks.

“The EM landscape may be looking brighter from a fundamental point of view. Growth has been stabilizing and inflation pressures falling, while external imbalances have adjusted within acceptable limits. With favorable comparables for beaten-down commodity exporters, we find reasons to be constructive on the EM earnings outlook, while relative valuations to DM remain attractive,” added State Street.

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