EMGF: A Surprisingly Good Emerging Market Fund Based On Factors (BATS:EMGF)

Emerging markets have been a very difficult part of the investment landscape to make money in, at least when looking at broad-based indices. China, which often makes up a large portion of these broad-based indices, has been a major drag for years. The question then is whether there is any way to use a factor-based approach to change that dynamic – whereby historically proven factors result in better go-forward performance.

This is the premise behind iShares Emerging Markets Equity Factor ETF (BATS:EMGF). This fund offers a novel way to access the growth prospects of emerging markets. It does this through a multifactor approach to investing in emerging-market equities, potentially providing investors with a lower-volatility way to invest in the asset class and beat the broader passive benchmarks like the MSCI Emerging Markets Index.

What are the quantitative attributes used for portfolio construction? The big ones that are well-researched academically are value, quality, momentum, and size. Historically, segmenting markets by each of these individually has resulted in better exposure and risk-adjusted returns over multiple periods. EMGF attempts to hone in on these factors given that strong academic research gives it the edge investors need for a frustrating asset class to invest in.

What does each of these factors represent? For value, it represents low-cost stocks that are likely underpriced regarding their intrinsic value. What about quality? These can be defined as sound and profitable firms with strong balance sheets. Momentum is very well documented when it comes to trends persisting. And, of course, size, which is ultimately about tilting towards comparatively smaller companies than the MSCI Emerging Markets Index.

By combining these factors, the fund seeks to build a portfolio that can capture various sources of potential outperformance, offering investors diversified exposure to the emerging markets equity universe.

A Look At The Holdings

When we look at the top holdings, we do see some meaningful concentration risk at the very top, with the largest position making up 8.2% of the fund.

What are these companies? Taiwan Semiconductor Manufacturing Company Limited (TSM) is a semiconductor giant in Taiwan, a crucial part of the global technology supply chain, manufacturing integrated circuits. Samsung Electronics Co., Ltd. (OTCPK:SSNLF) is a multinational conglomerate based in South Korea which makes various consumer electronics. Tencent Holdings Limited (OTCPK:TCEHY) is a Chinese tech firm that runs messaging and social media accounts. Alibaba Group Holding Limited (BABA) is a Chinese e-commerce company, which runs business-to-consumer and consumer-to-consumer online marketplaces and digital payment platforms. And Infosys Limited (INFY) is an Indian multinational corporation providing information technology and consulting services.

Sector Composition and Geographic Exposure

One of the big surprises to me here is that Tech is the largest sector allocation. I say this is surprising because broad-based emerging markets tend to be dominated more by Financials. And despite my concerns about the Tech sector in general, it’s refreshing to see an emerging markets fund that has that at the top.

To some extent, the Tech allocation makes sense. When we look at the Geographic exposure, India is up top. Again – refreshing given that China tends to dominate broad-based emerging market funds (yes, China is still a large allocation, but at least it’s more balanced here).

Peer Comparison

I’ve mentioned the MSCI Emerging Markets Index a couple of times here as a good comp against the fund. That of course means we can compare performance against the iShares Core MSCI Emerging Markets ETF (IEMG). This fund tracks the MSCI Emerging Markets Index. When we look at the price ratio of EMGF to IEMG, we find that EMGF has indeed outperformed. The factor approach, resulting in less China exposure relative to more Tech, has resulted in better returns.

Pros and Cons

The positives are solid here. By tilting to stocks with the right exposure to factors like value, quality, momentum, and size, EMGF aims to outperform the broader emerging markets equity universe over the long haul. And it clearly shows promise in doing just that. In addition, the fund provides nice diversification geographically using a rules-based approach.

Drawbacks? The targeted factors have historically demonstrated a positive return compared with their respective benchmarks and the broader market. However, there is no guarantee that these factors will continue to outperform the market or provide positive returns over any given period of time. In addition, there are risk factors unique to emerging market investments which include increased political, legal, counterparty, and currency risk given the fund is unhedged to forex.

Conclusion

This fund has been around for some time and looks promising to me, especially once we finally have a broader tailwind that favors emerging markets. I like the country mix, the sector allocation, and the relative performance overall. The factors are indeed based on numerous academic studies that prove them to be alpha generators. If you’re bullish on emerging markets, this is a good fund to consider overall, in my view.