EEMS vs. FEMS. Comparing small-cap emerging market equity ETFs

(This article was produced in partnership with Hoya Capital Real Estate)

Introduction:

Emerging market stocks are considered riskier than US or other developed market stocks. Small cap stocks are considered riskier than both large and mid cap stocks. These two ETFs combined both of those risks categories in their investment strategy. Here I will examine how it worked for these ETFs;

• iShares MSCI Emerging Markets Small-Cap ETF (NYSEARCA. EEMS:)
• First Trust Emerging Markets Small Cap AlphaDEX ETF (GET IN. FEMS:)

First, I revise my risk statement by looking at the history I found.

Since 1995, EM stocks have had the highest StdDev among the three stock classes when all market caps are considered. It’s worth noting that EM stocks have outperformed International Developed Markets stocks, even accounting for the additional risk.

Using MSCI Index data confirms that Small-Cap stocks have a higher StdDev than all global stocks, and many times more than global Small-Cap stocks. Their Sharpe ratio is the worst in the periods shown.

iShares MSCI Emerging Markets Small-Cap ETF Overview

Searching Alpha describes this ETF as:

iShares MSCI Emerging Markets Small-Cap ETF is managed by BlackRock Fund Advisors. It invests in the public capital markets of the global emerging region. It invests in stocks of companies operating in various industries. The fund invests in growth and value stocks of small-cap companies. It seeks to track the performance of the MSCI Emerging Markets Small Cap Index. EEMS started in 2011.

EEMS has $375 million in assets and comes with 68 bps in fees. Income seekers will not be happy as the yield is only 1%. That’s a fraction of the historical returns from the other ETFs reviewed here.

Examining the index

The MSCI Emerging Markets Small Cap Index includes small-cap representation in 24 emerging market countries. The 1,821-component index covers approximately 14% of the free-float market capitalization in each country. The small-cap sector tends to capture more local economic and sector characteristics compared to larger-cap emerging market sectors.

Source: msci.com/documents

The same PDF provides the following details: I understand the overweighting of smaller stocks, that’s the focus, and I even understand the below-average quality score; I’m lost, based on the data above, how this index scores above average with low volatility because it has a higher StdDev.

It is important to note that the index includes South Korea. Unlike other indices such as the FTSE, MSCI still classifies the country as developing rather than developed.

Review of EEMS holdings

iShares provides some basic information about the portfolio.

Both of the above returns are significantly higher than what Searching Alpha shows, revealing either number requires knowing how it is calculated. The sectoral allocations are:

Although not a dominant field, Information Technology still ranks first. Unlike many EM ETFS, Financials are not in the top two sectors, ranking fifth here.

It is equal to 78% in Asia and 12% in the Middle East/Africa region. It has little impact on Europe or the Western Hemisphere. The only currency hedge was against the Taiwan dollar. The leading holding (.97%) is the USD Cash Fund. The next 20 holdings, which make up 5.35% of the portfolio, are:

Sometimes, even with hundreds of stocks, a few have a large percentage; this is not the case with EEMS.

EEMS distribution review

Typical of international funds, the end-of-year fee is higher. Also note that payments are only made semi-annually, not quarterly. Seeking Alpha rates their payout history a “D-“.

First Trust Emerging Markets Small Cap AlphaDEX ETF Review

Searching Alpha describes this ETF as:

The investment seeks investment results that are generally in line with the price and yield of stocks referred to as the NASDAQ AlphaDEX® Emerging Markets Small Cap Index. The Index is designed to select stocks from the NASDAQ Emerging Markets Index (the “Underlying Index”) that are likely to generate positive alpha or risk-adjusted returns relative to traditional indexes using the AlphaDEX® selection methodology. FEMS started in 2012.

FEMS has $138M in AUM and currently yields 6.6%. Managers charge 80 bps fees. Despite its high yield and overall performance, AUM is a fraction of the other ETFs reviewed.

Examining the index

Index managers provide the following insights into their index:

The Nasdaq AlphaDEX® Emerging Markets Small Cap Index uses the AlphaDEX® security selection methodology to select and weight the securities from the Nasdaq Emerging Markets Index. The index is constructed by ranking the stocks in the Nasdaq Emerging Markets Index separately based on growth and value factors.

Source: indexes.nasdaqomx.com Index PDF

Important points listed in the Index PDF include:

• A security must be included in the Nasdaq Emerging Markets Index as of the Restructuring Reference Date.
• If the issuer has several classes of listed securities, the security with the highest average liquidity is generally considered.
• A security must have a consolidated market capitalization less than the mid-cap breakpoint (50th percentile) and greater than the small-cap breakpoint (90th percentile), as determined by Nasdaq.
• The index is reset semi-annually in April and October.
• Component selection factors.
  • The growth factors used for rating eligible securities are:
    • 3-, 6- and 12-month price appreciation
    • sales to price ratio
    • 1 year sales growth
  • The value factors used to classify eligible securities are:
    • book value price ratio
    • cash flow to price ratio
    • return on assets

After 11 steps of component selection and weighting, the Index applies a modified equalization process for which there is another PDF.

Review of FEMS holdings

The nurseries provided some essential data related to the portfolio.

The most recent sector allocations are shown below.

Materials as a leading sector helps explain recent results as the sector has performed well in this global inflationary environment. Notice to the financial statements below. hopefully this also shows that the index weighting rules are well designed.

FEMS appears to have fewer countries in its portfolio as the above cover 94% of holdings. At 23% in Turkey, they are betting big on a country that may not be the most stable in the world. Even without the exposure to South Korea, the portfolio is more than 50% in Asia.

Top 20 holdings

FEMS is also much more concentrated in its stocks, with the above accounting for more than 22% of the portfolio.

A review of the FEMS distribution

FEMS pays quarterly, but I don’t see a clear year-end or growth pattern. However, looking Alpha gives FEMS an “A” rating.

Comparing ETFs

For this analysis, I have included the iShares MSCI Emerging Markets ETF (EEM), which is the uncapped version of EEMS; plus the SPDR Portfolio Developed World ex-US ETF (SPDW) to represent non-US Developed Market performance.

Of the two EM SC ETFs, FEMS has done better for investors than EEMS. Small-Cap focus outperformed investing in all EM stocks. FEMS has also closely followed the results of SPDW. One could consider combining FEMS and SPDW instead of having a full international ETF like the iShares MSCI ACWI ex-US ETF ( ACWX ), which would allow the investor to set the weighting between EM and DM stocks.

Here’s how the features compare among these five ETFs.

Portfolio strategy

Most of the sources I found have a favorable investment outlook for EM stocks compared to other stock markets; no distinction was made against small cap sectors. I list a few next.

After a volatile start to 2023, Emerging Markets should deliver strong returns; The outlook for Emerging Markets should turn more favorable after inflation and interest rates peak in the US and China. China stocks are likely to strengthen due to both zero-covid and property tightening reversals.

Source: newsroom.bankofamerica.com

The picture for 2023 may actually be brighter. Emerging markets can benefit from both poles of the global economy. The US, where interest rates could rise, weakening the historically strong dollar, and China, which is reeling from its slowest growth in decades. “All eyes are on the dollar and the way China reopens,” said Gaurav Malik, chief investment strategist at State Street Global Advisors. “We are cautiously optimistic about both.”

Take out China and 2022 wasn’t so bad, says Jitania Kandhari, head of emerging markets equities research at Morgan Stanley Investment Management. Nine of the year’s top 10 stock markets were in emerging markets.

Source: barrons.com

Led by China (4%), overall EM GDP growth (2.9%) outpaced any of the developed markets.

While US dollar strength is negative for EM countries in terms of dollar debt repayments and higher export costs, other factors should lead to growing economies such as:

• Younger populations with an average age of 34.
• More than 50% of the world’s population lives in an EM country.
• Almost 50% of global GDP, with GDP growth of 67% in the last decade.
• Educated workforce with an average of 10 years of schooling.
• GDP per capita USD 38,000; or about 80% of the UK.

Final thoughts

Holders of multiple global or international funds should be exposed to EM stocks, although they likely have minimal exposure to small-cap stocks. While a good fund home page will provide a complete list of holdings, with country-level allocations, fewer market cap allocations are provided. Industry sites like Fidelity or ETFDB.com usually do. Knowing your impact will help you decide if you want to add more.