Hedge Your Emerging Market Exposure With This Low-Volatility ETF
Well diversified portfolios should have an allocation to emerging market equities even when they are not favorable. There are many ways to get exposure to emerging market equities including both active and passive funds. A low volatility emerging market ETF provides exposure to the asset class with less volatility than a traditional investment. If you’re one of those investors that time your entry into certain asset classes or positions and take big positions when you do so, good luck to you. If you’ve been successful using this strategy then congratulations, you should probably start your own hedge fund and make an additional 2% and 20% of profits from other people’s money. If you’re like the rest of us however, the better strategy is to be diversified across all asset classes, all the time, and increase or decrease allocations to each based on the outlook for each asset class relative to others. One asset class that is not getting much love these days, and for good reason, is emerging market equities. According to the MSCI Emerging Market Index, these markets include China, Korea, Taiwan, Brazil, Mexico, Russia, and India, to name a few. (Note: Korea is not included in all emerging market indexes and may also be included in several developed market indexes). According to the iShares MSCI Emerging Markets ETF (NYSEARCA: EEM ) , emerging markets are down almost 17% over the last year. That would have been a painful decline in your portfolio if not well diversified with, say, the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) , which had a 2.7% return over the same period. While I have been telling clients to lighten up on emerging markets, by no means did that mean to sell all their positions. In fact, we might soon be getting to the inflection point where emerging markets become a good buying opportunity. Maybe we are already there. There are many experts, economists, analysts, and pundits that would argue that it is still too soon to buy EM. To which I say, you should already have some EM, even if it’s a small allocation. If emerging markets scare you but you might kick yourself if you miss the upside that usually happens too quickly to react, I have a solution. Instead of investing in emerging markets through EEM, why not invest in the iShares MSCI Emerging Markets Minimum Volatility ETF (NYSEARCA: EEMV ). It has a beta to the S&P 500 of 0.3 and a standard deviation of 10% over the last 3 years. Compared to EEM, with a beta of 0.6 and a standard deviation of 12.5%, this is one way to get some exposure and not lose any sleep at night. Over the last year, EEMV is down 13.2%, compared to EEM which was down 16.6%. (click to enlarge) Doesn’t seem like much of a difference and EEMV will tend to lag in a rapidly rising market, but for a conservative investor that doesn’t like volatility, it’s a great option. Over the long-run, low volatility strategies tend to do well relative to the comparable traditional strategy. After all, if you’re down 20%, you need a 25% return to breakeven, but if you’re only down 10%, your breakeven return is only 11%. Since EEMV was launched, it has outperformed EEM by over 15%, because it loses less when the markets decline. (click to enlarge) The difference between EEMV and EEM is quite simple: the volatility of each stock is evaluated along with the correlations between stocks. And then a number of constraints are applied to ensure adequate diversification and representation of the broad market while minimizing volatility. The underlying portfolios have slightly different allocations by country, sector, and top holdings, but both provide well diversified exposure to the broad market. EEMV is a much smaller fund with only $2.7 billion compared to the much larger EEM with $27 billion, but $2.7 billion is a good size fund and it hasn’t been around for very long. I anticipate that as emerging market equity volatility increases, more flows will be directed to EEMV instead of EEM. Bottom line here is that every portfolio should be well diversified including an allocation to emerging market equities, even when the consensus view is that it is still too soon. Stay underweight, stay defensive, and consider using the minimum volatility alternative. Source: iShares.com, PM101, Yahoo