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Evaluating Emerging Market Funds with YCharts

All advisors seek to maximize their clients’ returns, but emerging market funds may feel like uncharted waters when looking to boost a portfolio’s performance.

Bigger risks can lead to bigger rewards, and emerging economies’ pace of growth and market inefficiencies offer potential for higher returns. These inefficiencies are due to a lack of analyst coverage, investor participation, liquidity, or regulation relative to developed markets. 

So what exactly constitutes an “emerging market”? The definition is wide, but it encapsulates any underdeveloped nation transitioning into a developed one. This may reference previously-closed economies such as Poland or Hungary, or nations undergoing a rapid transformation like China and India. 

While developed economies wrestled with the negative impact of COVID-19 during the fourth quarter of 2020, emerging markets found space to grow, strongly outpacing the S&P 500, MSCI World (which holds developed-nation stocks), and International Developed Markets (which includes the MSCI World ex. USA). 

Emerging Markets vs. Developed Markets in Q4 2020

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Types of Emerging Market Equity Funds

A lot has changed in the past few decades; emerging market investing is no longer out of arm’s reach for advisors. The selection of funds targeting emerging market strategies is wide and diverse, and only continues to grow. One route for emerging market exposure is through actively-managed mutual funds, which allow portfolio managers to capture the inefficiencies within emerging markets. Not willing to pay the higher fees accompanying active management? You’re not alone. Emerging market ETFs offer lower costs, while still offering a diverse selection of strategies. 

A few of these strategies include region or country-specific funds, which allow for quickly targeting and acting on market views. For instance, if you wanted to act on China’s relatively quick economic recovery from the COVID-19 slump, investors may have looked into the iShares MSCI China ETF (MCHI), the Invesco China Technology ETF (CQQQ), or the WisdomTree China ex-State-Owned Enterprises ETF (CXSE). 

In the chart below, each of these Chinese ETFs strongly outperformed the S&P 500 year-to-date in 2020, while the largest drawdown in March was also far less severe.

Chinese ETFs Performance vs S&P 500 through 2020

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Risks of Investing in Emerging Market Funds

Emerging market equities are exposed to some innate risks which developed countries may not have, such as political risk, commodity-price risk (given the tendency for emerging economies to be strongly linked to key exports), monetary policy shifts, and natural disasters, among others. Despite the resilience shown by the Chinese ETFs above, these risks tend to lead to larger drawdowns in emerging market funds during periods of economic stress.

Below, the chart depicts the max drawdowns in both SPY and the MSCI Emerging Markets ETF since 2003. Emerging market equities lost roughly two thirds of their value, and over 11 percentage points more than the S&P 500, during the Great Recession, proving the risks accompanying investing in emerging market funds. “Buy and hold” may be tough to pitch when looking at a 66% drawdown.

Max Drawdowns: US vs Emerging Markets

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How to Evaluate Emerging Market Funds

Screening for Emerging Market Funds

While finding an ETF for a certain region or country may be quick (thanks to our predictive search bar), the hunt for an actively managed emerging market fund can be tricky without a robust screening tool. 

The YCharts Fund Screener helps you narrow in on a suitable fund for your clients in just a few steps. Start with the pre-built Best Performing Actively Managed Emerging Markets Funds, as shown below. This Fund Screener template filters for the top 50% of funds ranked by Total NAV Returns over several look-back periods. Sorting the screen results by YTD Total Returns (Daily), you have a list of the best performing emerging markets funds. Now let’s dig into the top results further.

EM Screen Filters
EM Screen

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Comparing Funds with Quickflows and Custom Reports

After you’ve found new funds to further evaluate, click on the fund’s symbol to view its quote page. Directly from the fund’s quote page, select the “Quickflows” tool on the right side of the page. Click “Comparison” at the top of the menu, and select up to 12 securities to further analyze. 

For the comparison below, we’ve selected three China-focused emerging market funds from the screen results above: Matthews China Investor,  Columbia Greater China A, and Aberdeen China A Share Equity A. If you’re interested in the equity styles of the funds you’ve selected, click “Equity Style Exposure”, which will bring you to a Comparison Table of the three funds.

EM Fund Comp Table

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Notably, the Matthews China Investor is the most exposed to large and mid cap blend stocks, and also has the most diversity in its exposure. If you’re looking for large cap growth, you may opt for the Columbia Greater China A.

Once your search has been narrowed down to just two funds, more in-depth analysis is needed to decide which to add to your client’s portfolio. Custom Reports allow you to dive into the analytics and performance history you’ll need to make the best decision for your clients. Below is a snapshot of a side-by-side comprehensive report comparing the Aberdeen China A Share Equity A and Matthews China Investor.

EM Fund Comparison

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Communicating Portfolio Impact with Model Portfolios

Emerging market equities can potentially add performance and diversification to a portfolio; but how can you quantify this, or present it in an easily understood way to a client? YCharts Model Portfolios can show how a portfolio looks with, and without, a certain holding. 

Below is a comparison of two portfolios; Portfolio A is a balanced 90/10 portfolio with no emerging market holdings, and 10% allocated to the Vanguard FTSE Developed Markets ETF (which tracks developed nation equities excluding the US). Matthew’s offering was too good to pass up, so Portfolio B replaced the Vanguard FTSE Developed Markets ETF with the Matthews China Investor, with all weightings remaining the same. See some of the differences below.

Geographic Exposure

Portfolios

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While adding emerging market exposure did increase the portfolio’s expense ratio by about 11 basis points, the effect on its alpha and returns is outsized. Alpha over a 5 year look back increased from -0.45 to positive 0.88, while YTD total returns increased over 3 percentage points and distribution yield and Beta (5Y) remained relatively unchanged. With this quick report, you can show a client the effects that emerging market exposures can have on their portfolio with ease.

Emerging markets can feel a bit murky at the outset. Use YCharts’ powerful tools to demystify this huge portion of the world’s equities, and provide a diverse set of investment opportunities for your clients.

 

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Disclaimer

©2020 YCharts, Inc. All Rights Reserved. YCharts, Inc. (“YCharts”) is not registered with the U.S. Securities and Exchange Commission (or with the securities regulatory authority or body of any state or any other jurisdiction) as an investment adviser, broker-dealer or in any other capacity, and does not purport to provide investment advice or make investment recommendations. This report has been generated through application of the analytical tools and data provided through ycharts.com and is intended solely to assist you or your investment or other adviser(s) in conducting investment research. You should not construe this report as an offer to buy or sell, as a solicitation of an offer to buy or sell, or as a recommendation to buy, sell, hold or trade, any security or other financial instrument. For further information regarding your use of this report, please go to: ycharts.com/about/disclosure

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