One of the hottest asset classes in 2009 by far was Emerging Markets, which includes stocks from developing markets like China, Brazil, Korea, Taiwan, India, and South Africa. Two of the most popular ETFs in this category are the iShares MSCI Emerging Markets Index (EEM) and the Vanguard Emerging Markets ETF (VWO).
Which one should you choose?
Similarities. Both are primarily passively-managed and based on the MSCI Emerging Markets Index. EEM has been around longer but both currently have similar levels of assets, with $40B for EEM and $34B for VWO.
Differences. EEM is less expensive than most other actively-managed Emerging Markets mutual funds at a 0.72% annual expense ratio, but Vanguard is significantly cheaper still at 0.27%. EEM has a much higher average trading volume, as it has a higher popularity amongst institutional investors and active traders.
While they track the same index, both ETFs have their own sampling methods to replicate that index. EEM holds 439 stocks with an average market cap of $23.1 million, while VWO holds 816 stocks with an average market cap of $17.6 million. Unfortunately, Morningstar chose the MSCI EAFA Index as their benchmark for statistical comparison, so it’s hard to see exactly historically which one has been following the index more closely.
Performance-wise, iShares’ EEM has recently been lagging behind Vanguard, as was pointed out in this IndexUniverse post. In 2009, EEM rose 68.8% but VWO gained 76.3%, nearly 8 percentage points more.
This has led to a significant outflow of funds recently from EEM into VWO:
However, if we look back to 2008 EEM dropped 48.9% while VWO dropped 52.5%. VWO isn’t old enough to compare 5- or 10-year historical returns, but if you compare 3-year annualized trailing returns VWO only beats EEM slightly at 2.69% vs. 2.60%. That’s actually surprising given the 45 basis point expense edge for VWO.
Conclusion. Due to their differences, either EEM or VWO may outperform each other in the short run. However, historically the significantly lower expense ratio of VWO has won out, and I would expect it continue to do so in the long run. VWO also holds more stocks and thus would seem to track the MSCI index more closely, while EEM offers more liquidity if you’re trading high amounts of shares at once.
Disclosure: I am or will be invested in VWO or the mutual fund equivalent (VEIEX). The reason I started this research is because I am currently trying to figure out how to switch to an ETF since the Vanguard fund VEIEX is both more expensive at 0.39% annually and has both a purchase fee of 0.50% and a redemption fee of 0.25%. Ouch! You can compare the total ongoing costs of VWO vs. VEIEX easily at this Vanguard calculator.
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In comparing VWO and VEIEX, one thing I have never been clear on is the relationship between the purchase/redemption fees on the fund side, and the holders of the ETF share class.
Generally in discussions of VEIEX and similar Vanguard funds it is pointed out that the purchase/redemption fees are not a “load” — or even a “real” fee — because they are simply paid into the fund. Owners of the fund benefit from the fees coming in, as well as reduced transactional costs from speculative trading.
However, what I am wondering is whether shareholders of the ETF class are equally benefiting from those fees. If so, that would really add insult to injury!
I hold both of these but focus more on EEM (I will eventually consolidate into EEM only). The reason for this is that I use a covered call strategy* to generate extra income (higher return) on my holdings and EEM has a much more liquid options market. Using rough estimates, there are 200,000 contracts on EEM – meaning it’s easier to buy and sell EEM options, and narrower bid/offer spreads. But for buy & hold, Vanguard’s expenses are hard to beat.
* I sell short term, out-of-the-money call options on EEM and several other widely-traded index funds. The strategy is to generate a few extra % per year while selling contracts at a strike price sufficiently high that it is not likely to result in the option being exercised. THIS STRATEGY IS DEFINITELY NOT FOR EVERYBODY, AND CAN RESULT IN LOSSES IF YOU DO NOT KNOW WHAT YOU ARE DOING.
Nice post, but I should point out that the $34B asset figure for VWO includes both the ETF and all Vanguard’s linked mutual funds. As an ETF, it has $19B in assets and just over 500M shares outstanding. In constrast, EEM has about 866M shares outstanding and $34B in assets, making it still the clear leader. However, for the reasons Jonathan mentioned, I still have the bulk of my emerging market money in VWO.
I own both VEIEX and VWO. I started with VEIEX several years ago and just bought some shares of VWO a few days ago due to the recent dip in emerging markets.
I still like the VEIEX better for these reasons:
-I can dollar cost average it automatically.
-0.50% purchase fee is less than a brokerage fee except on very large transactions.
-0.50% purchase fee is paid to the fund, not the management, so I get it back in distributions anyway.
-One day I’ll have admiral shares with lower cost.
The reasons I bought VWO recently:
-I can move money around faster in a brokerage account to take advantage of temporary lows.
-My stock trades are free up to a point (thanks Zecco)
I’m sure your aware but just remember if this transaction happens in a taxable account to be aware of any wash sale rules if you try to take any losses.
I guess my question is why not buy VEU and if there is a certain country you want more exposure to just buy the country specific country ETF in addition? Too me it seems I have more control as I question the emerging markets in the past are going to keep thier performance in the future and I feel there could be some mature markets that could outperform the emerging ones.
@Pete – That is a good question. I don’t know the answer. My uneducated guess was always that since the mutual fund benefits from the tax structure of ETFs for new/destroyed ETF shares, the ETF benefits from the purchase/redemption fees of the mutual fund. If you look at the realized/unrealized gains and losses on Vanguard.com based on NAV, they differ by only 0.02%.
@Ken – Thanks for the clarification, I just went by the Morningstar numbers. Impressive that EEM has more than VWO and VEIEX combined.
This post comes in at a very appropriate time for me. I just contributed to my Roth IRA, and was hoping to buy VWO.
How do people feel about using Roth IRA funds to buy into emerging markets?
So sorry to subject you to further analysis paralysis, but in the end, I would not want to own any of these.
I think Scott is onto something. In Morningstar’s analysis, although EEM has nearly 3 times the assets of VWO, EEM retains 20 to 30 times the daily dollar trading due to larger percentages of institutional investors. In essence, if you want to buy low and sell high, time and time again, go with EEM. If you wish to buy and hold, go with VWO.
When I select mutual funds, I want the person I hire (the fund manager) to be an Ivy League grad or a graduate from the UK’s equivalent, Oxford or Cambridge. The managers for VWO graduated from St. Joseph’s and Villanova, while the managers from EEM graduated from NYU and Colorado. These are fine universities, but not quite Ivy League. In the past, Mark Mobius was the exception to this rule. He is the guru when it comes to emerging markets and graduated with a PhD from MIT (not too shabby). I would not select a fund or ETF run by Mobius at this point, he is after all, nearly 74 years old. I’d rather hire someone else.
VWO and EEM both have a sliver over 50% regional exposures to “Asia, except Japan.” Both have the same top 4 countries as the homelands of their stock selections: Brazil, China, Korea, and Taiwan. I asked myself if these were the countries that I would invest in now for the long term. There are so many other countries that are considered emerging or developing markets.
I am curious what T Rowe Price will do with regards to ETFs. Many of their mutual funds have Ivy League managers. If this is their same formula with reasonable expense ratios, these are ETFs that I may consider with the intent of a buy and hold strategy. I’ve opted to wait for their products until I decide to jump on the ETF bandwagon.
@Step3 using sharebuilder, it would be very easy to dollar cost average with vwo for only $4 per tade, just set up an auto purchase plan.
@Mario long term, emerging markets offer the best potential, a roth isn’t a bad idea. If you have more than 5k to put away every year emerging market funds and etfs can be held outside a roth since they usually don’t have high dividends. Focus on keeping bonds, reits, large cap and value stocks/funds in your roth.
@step3 with sharebuilder you could also set it to invest “when funds available” set it at say $800, then auto deposite $300 per month into sharebuilders money market, and once it reached $800(or whatever you set it out) it would buy.
@Mario, The dividends from VEIEX quite modest, similar to S&P 500. An IRA purchase would be better spent on a tax inefficient fund like a REIT. I’ve also owned VGSIX for a while, and received about 3 times the dividends on the about the same amount invested.
@Jake, even using Sharebuilder I would need to be investing about $500 a month to see similar fee’s. Using Vangaurd’s calculator, you can see that for a $300/month investment @8% growth the breakeven point is about 10 years, at which time I switch to a lower cost structure.
Jake, that is a good plan but it does not have the benefit of dollar cost averaging. I typically like to do all my purchase twice a month; because that is how I get paid and it provides the maximum flexibilty for dollar cost averaging.
Jonathan – How are you planning to get automated Dollar cost averaging with VWO?
I don’t really know much about ETFs but I had a question. My broker is Fidelity and they recently offered free trades on 25 Ishares ETFs. Do any of you know how I can figure out the differences between each of these? On Fidelity’s site, they only show the top 10 holdings for each ETF and they all seem to be financial stocks so that doesn’t help me at all. According to Jonathan in this article, an ETF can have 400 or 500 stocks. Is there any way for me to view the rest (or at least a larger amount) of the holdings of each ETF?
@Eric On iShares website, there is a link above the top 10 daily holdings to “View all holdings” but it requires free registration. Incidentally The Finance Buff’s blog just had a post referencing these ETF’s and accordingly strategies:
http://thefinancebuff.com/2010/02/low-minimum-index-funds-and-commission-free-etfs.html
@Eric
The easiest way to view all of the holdings is to go to the ishares website: http://us.ishares.com/home.htm
On the left side of the page, under “fund finder”, you can select the ETF you are interested in. Once you get to your selection, the left side of the ETF’s page lists “fund documents”. Click on “monthly holdings”, and that should bring up an Excel spreadsheet of what that ETF holds. You might have to slide the panes over a bit to see the entire contents of the cell. IWV, for example, holds 2,971 stocks, and has a very long spreadsheet.
If you want to compare some ETFs alongside one another, you can use their “fund screener” under “tools and charts”. Choose the ETFs you are interested in, and another Excel spreadsheet will show you a comparison of your selections. There are other ETF comparison websites out there. Vanguard’s ETF comparison tool is a bit better than ishares. Although it only let you do 2 at a time, you can compare ETFs from different organizations.
Ron and SanDance,
Thanks a lot for your help. I will have to analyze those sites tomorrow when I have more time.
So a more general question. How do you know what different indexes track exactly? I mean I get a general idea from the name. BNY Emerging markets 50 ADR index is probably 50 companies chosen somehow from the emerging markets sector (brazil, india, china, etc). MSCI Emerging Markets index is also likely to try to generally follow the performance of those emerging nations.
But really, other than really well known things like the S&P 500, I don’t have a good feel for what is it that all these hundreds of indexes are tracking. How you determine conceptually what these different indexes are really trying to do?
@Ron – I am not sure why you care if an Ivy Leaguer manages an index mutual fund. If you are talking about creating an index, I may give more credence to the argument, but not much. For following an index, the education has little to do with the process. The only question is purchasing more and more of the components of the index as new investments arise.
As you can see from EEM, they haven’t replicated the index that well. There have been large deviations from the underlying index. This is because the EEM product hasn’t brought in enough assets to hold all the positions in the index. VWO has a leg up as it is a share class of the Vanguard funds that have considerably more assets under management.
Also, I think you will find the vast majority of actively managed emerging funds managed by Ivy League hot shots have underperformed the MSCI emerging index, which both EEM and VWO are based.
Ron: It’s touching that you are answering the altruistic impulse to sponsor some hungry fund managers. The Ivy League types, in particular, have much greater needs, so your help is no doubt appreciated.
Wow, I love the fan mail. Feel free to pick and choose any actively- or passively-managed ETF that you feel fits in your portfolio. Personally, I’d like to hire someone who could manage the funds (actively or passively) within my nest egg and who have a solid educational foundation. Wisdom tree has ETFs managed by folks who went to California State Universities. If you feel comfortable with those guys, when then by all means, go for it. After all, most of them are indexed, right? Seriously, if you are going to hire someone to manage your money, whom would you prefer, a graduate of San Francisco State or Yale? San Jose State or Harvard? Cal State Northridge or Princeton? C’mon, this is not a tough decision.
And you know what else? ETFs simply haven’t had a long enough track record for my tastes. This fact has kept me away from this investment vehicle. Only recently has Morningstar been releasing some analysis and opinion on some particular ETFs. For now, you can count me out; I’m just not as much an early adopter as some investors are.
The point — for those of us who have decided that trying to beat the market is a fools errand — is that “hiring” an active manager is about as sound an investment strategy as buying lottery tickets. This is true whether they went to Nebraska State or MIT (and I say this as someone who went to Princeton).
To be clear, selecting a fund based on a manager’s background is only one criterion for narrowing down a choice of investment. Of course, I’d like to see the manager’s track record as well. Certainly, if they went to a good school, and yet continues to have poor performance, I would not look at that manager favorably. In addition, Morningstar has in recent years added “Stewardship” grades to their analysis. This in part reflects whether or not the manager is investing his/her own money into the fund. In sum, there are several aspects of a fund to consider which help us decide on how we invest. I look at expense ratio, holdings, tax efficiency, Morningstar analysis, etc… I never said pick a fund solely because of the person that runs it. That would be ludicrous. Investors have to decide on comprehensive investment strategies that work for them. So my point, actually, is that I am not interested in ETFs due to a relatively brief time period that they have been in existence and I would instead prefer a well-educated person at the helm running a fund for a long time span. And there isn’t anything wrong with buying lottery tickets from time to time…hey, you never know.
Did you decide what to do? I’m contemplating moving my VEIEX to VWO for the same reasons.
It’s the one expense ratio out of whack in my portfolio.