As the ETF landscape continues to change and new product innovation remains robust, iShares is looking to further expand its offerings of emerging market ETFs.
The leading ETF provider is expected to introduce two new ETFs: the iShares MSCI Emerging Markets Financials Sector Index Fund and the iShares MSCI Emerging Markets Materials Sector Index Fund. One reason that iShares has decided to introduce these new ETFs is the appeal of emerging markets. In October 2009, net inflows into the iShares MSCI Emerging Markets Index (EEM) and the Vanguard MSCI Emerging Markets ETF (VWO), the two most actively traded and largest emerging market ETFs, accounted for 45% of all net inflows into exchange traded funds.
There is no doubt that international ETFs are becoming more popular and can offer great diversification benefits to a portfolio, but before considering adding more than one, it is equally important to consider concentration and overlap.
On one end of the spectrum are the broad-based ETFs, like EEM, which diversify assets over a vast array of emerging market equities. EEM’s top three country holdings are Brazil, China and Taiwan, with 16.2%, 15.7% and 10.6% allocations respectively. On the other end of the spectrum are the concentrated funds which give exposure purely to one country, like the iShares MSCI Turkey ETF (TUR). These two ETFs enable one to gain exposure to emerging markets, but in completely different ways and with completely different risk profiles.
A second factor to consider is the holdings of the ETF. In many emerging market ETFs, single companies can dominate performance because of their relative size and the fact that the ETF uses market capitalization or modified market capitalization to allocate assets. An example of this can be seen through the iPath MSCI India Index ETN (INP), which has 59 holdings and allocates nearly 23.5% to two companies. A well-diversified ETF will allocate no more than 10% of its assets to its top holding.
Thirdly, it is equally important to be mindful of the underlying sector allocation of an emerging market ETF. Take TUR, for example – the ETF holds 80 different stocks, however it allocates more than half of its asset base to the financial sector. Another example is the Market Vectors Russia (RSX) which holds 36 different stocks but allocates more than 50% of its assets to the oil, gas and energy sector.
It is important to know what an ETF holds and tracks before utilizing it to build a well-balanced portfolio. You don’t always get what you think you are getting.
