Emerging market investments are definitely an attractive
proposition for long-term investors. These nations are often
characterized by high economic growth, diminishing levels of
poverty, rising per capita income and moderately high levels of
inflation to stir the growth process. (read Emerging Market Small
Cap ETFs: Freefall Continues)
These markets have little correlation with developed markets and
can make way for a compelling investment for investors looking for
international diversification in their portfolio.
Exchange traded funds (ETFs) provide an excellent opportunity to
tap into the growth potential of emerging markets. However, many
products in this space have slumped badly over the last one year
and year-to-date basis, especially the small cap ETFs.
Often times, this is because small cap stocks are more sensitive
to economic trends and market sentiment. Therefore, during an
uptrend or downtrend, these ETFs tend to out/under-perform the
broader markets.
The Market Vectors Russia Small-Cap ETF (RSXJ),
the Market Vectors Indonesia Small-Cap ETF (IDXJ)
and Market Vectors Brazil Small-Cap ETF (BRF) are
some products from this space that have underperformed in
particular. RSXJ was negatively impacted primarily due to its high
allocation towards the energy sector, and as a result it is down by
almost 15% this year. The sector as well as the Russian economy as
a whole was hit hard by falling crude oil prices. (read Why Russia
ETFs Are Not A Debt Crisis Safe Haven)
Another ETF which is a relatively new product in the emerging
market small cap ETF space, IDXJ, has lost nearly 13% since its
inception back in March 2012. The product allocates a large
proportion of its total assets in the financial sector (39.5%)
while the Indonesian market is generally more volatile than other
large emerging markets anyway.
The financial sector is highly correlated with prevalent
economic trends and investors tend to shun this volatile sector
during economic uncertainly. Therefore, given the extremely
volatile global economic situation, investor appetite towards the
financial sector was reduced substantially, especially in the
case of risky Indonesian securities (see Three Financial
ETFs That Avoid Big Bank Stocks).
Having discussed some products from the space that have suffered
massively, it is prudent to note that other emerging market small
cap ETFs have substantially outperformed their counterparts and
generated positive returns despite the broad downturn in the
space.
In this regard we would like to highlight two Chinese small cap
ETFs that have been able to weather the storm both of which have
crushed the trend so far.
The iShares MSCI China Small Cap Index (ECNS)
has been able to post double digit returns so far this year. It has
returned 10.38% year till date basis. Unlike other ETFs in this
space, ECNS has a very well spread out portfolio, both in terms of
individual stocks and sector holdings.
This ensured that performance of the ETF was not dependent on
any particular stock or sector. The ETF has 337 individual holdings
with only 12.38% allocation towards the top 10 holdings. This
characteristic is what sets ECNS apart from the other three
products from this space already discussed. BRF, IDJX and RSXJ have
33%, 63% and 57.06% allocations respectively in their top 10
holdings.
ECNS tracks the MSCI China Small Cap Index, which measures the
performance of the small cap Chinese equities. The ETF debuted on
September 2010 and has $15.53 million of assets under its
management. Approximately 3,456 shares of ECNS are traded each
day.
Also, another small cap focused China ETF, the Market
Vectors China ETF (PEK), has been able to stay in the
green so far this year. PEK, which tracks the CSI 300 Index, has
returned 6.73% this year-till-date.
The benchmark index comprises of 300-A listed common stocks
which are traded in the Shenzen or Shanghai stock exchanges.
However, the ETF does not invest in any particular stock, but takes
positions in swap contracts of the underlying index to replicate
the performance of the index.
This removes some worries with respect to tracking error, but
the fund often trades at a premium to its underlying thanks to a
lack of swap partners and contracts.
Moreover the well diversified portfolio of the index enables PEK
to reduce concentration risk. The top 10 stocks in the CSI 300
Index have been given only 20.53% weighting.
Chinese Economy in Focus
Clearly, the Chinese economy continues to lead the group of
emerging nations. The country continues to grow at an above-average
pace relative to its other emerging counterparts. With the CPI
number reducing from 3.44% in April 2012 to
3.034% in May 2012, we witnessed a much needed
reduction in the benchmark interest rates from 6.56% to 6.31%.
Earlier, the Chinese central bank had incorporated five
consecutive rate hikes from October 19, 2010 in order to
tackle rising inflationary problems.
Additionally, it is worthwhile to note that although China
generally has a heavy dependence on exports to developed nations,
many of the companies in PEK and ECNS do not. Instead, they do a
great deal of their business in the local Chinese economy, helping
to insulate them from global troubles.
Given this and a modest increase in the value of the yuan, and
it has clearly been a good time to be heavily invested in China
when compared to other countries on the list.
Whether this trend can continue is unclear, but it does appear
as though China small caps can hold up better in the global turmoil
than some of their more natural resource-focused peers. Due to
this, it may be best to shift towards these securities, especially
if commodity prices stay weak and the outlook for developed
markets remains uncertain.
Emerging Market Small-Cap ETFs: Comparative
Analysis
The following table summarizes the relative performance of the
five ETFs from the emerging market small cap space.
Fund
|
Country
|
YTD Returns
|
Concentration in top 10 holdings
|
Expense ratio
|
Total Assets
|
BRF
|
Brazil
|
-0.38%
|
33%
|
0.59%
|
$460.16 million
|
IDXJ
|
Indonesia
|
-13.00%
|
63%
|
0.61%
|
$4.11 million
|
RSXJ
|
Russia
|
-14.78%
|
57.06%
|
0.67%
|
$9.04 million
|
ECNS
|
China
|
10.38%
|
12.38%
|
0.59%
|
$15.37 million
|
PEK
|
China
|
6.73%
|
20.53%
|
0.72%
|
$16.38 million
|
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MKT VEC-BRZL SC (BRF): ETF Research Reports
ISHARS-MS CH SC (ECNS): ETF Research Reports
MKT VEC-INDO SC (IDXJ): ETF Research Reports
MKT VEC-CHINA (PEK): ETF Research Reports
MKT-VEC RUS SC (RSXJ): ETF Research Reports
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