Focusing On Emerging Markets Growth With This ETF

Emerging markets equities and the corresponding exchange-traded funds are among this year's best-performing assets, but that is also a reminder that not all emerging markets ETFs are created equal. Investors looking for the next frontiers of developing markets economic growth may want to consider an ETF such as the Global X Next Emerging & Frontier ETF (NYSE: EMFM).

The Global X Next Emerging & Frontier ETF is up 16.1 percent year to date. EMFM tracks the Solactive Next Emerging & Frontier Index, a benchmark of developing economies that excludes many of the staples of traditional emerging markets funds. Notably, EMFM does not hold stocks from Brazil, Russia, India, China (BRIC), South Korea and Taiwan.

Do Your Research: Advantages, Drawbacks

There are advantages and drawbacks to EMFM's strategy.

“Yet we believe popular market capitalization-weighted emerging market indexes dilute the high-growth opportunities in the emerging markets that investors are seeking,” said Global X in a recent note.

Related Link: A Steadier Course For China ETFs

“One cause for this 'dilution' is due to the fact that market cap-weighting schemes tend to overweight the countries that have already experienced periods of rapid growth and are now decelerating as they mature into middle-income economies.”

At the end of the first quarter, EMFM had 74 percent of its weight allocated to emerging markets with the remainder assigned to frontier markets. However, some of the ETF's frontier members are already classified as emerging markets or soon will be. That includes Pakistan, Qatar and the United Arab Emirates.

One of the risks presented by EMFM is that when the biggest developing economies, such as China or South Korea, are driving the broader emerging markets space higher, the ETF could potentially lag its more traditional counterparts.

Another risk when skirting developing economies such as China, India and South Korea is a larger emphasis on commodities. For example, EMFM's holdings have larger commodities as a percentage of GDP than the BRICs plus South Korea and Taiwan, according to issuer data.

“The combined population in the Next EM + FM countries are the largest in the world and forecast to expand at twice as fast as the BRIC + ST countries and four times as fast as developed economies,” said Global X. “Coupling these demographics with 37% lower labor costs than the BRIC +ST countries, it’s possible that the Next EM + FM countries could benefit from a demographic tailwind, which might accelerate their growth.”

Thailand, Indonesia and Mexico combine for almost a third of EMFM's weight. The $15.1 million ETF holds just over 200 stocks.

Related Link: Don't Have Your Eye On China? You Should