For U.S. investors, diversifying into emerging markets is a great way to potentially add more potential growth to one’s portfolio. However, without local market experience and boots-on-the-ground knowledge, it can be difficult to know which markets and which specific stocks to invest in.
That’s why many investors are well-served by checking out an ETF like the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM). This $24.6 billion ETF from BlackRock (NYSE:BLK) gives investors instant diversification with access to nearly 1,200 emerging markets stocks from around the world and across a wide array of industries. EEM launched in 2003 and is a passively-managed ETF that seeks to replicate the results of the MSCI Emerging Markets Index before fees and expenses, according to iShares’ website.
Why Consider Emerging Markets?
There are several reasons why U.S. investors (or investors living in any developed market, for that matter) should consider adding some emerging market exposure to their portfolios. First, investing in emerging markets allows investors to tap into more growth potential as these countries develop and “catch up” with developed markets in terms of economic development, lifestyle, and infrastructure.
Many of these emerging market countries not only have growing populations, but they’re also home to growing numbers of people who are joining the global middle class, and consumption will increase as more people join this demographic.
A second key reason to consider investing in emerging markets is that the valuations are much cheaper than you’ll find in the S&P 500 (SPX) or other major U.S. indices. For example, the stocks in the S&P 500 currently sport an average price-to-earnings multiple of nearly 22. On the other hand, the average P/E multiple for EEM is just 11 — 50% less. While the S&P 500 certainly deserves some premium given the safety and long-term outperformance of U.S. markets, this is a wide gulf. This lower valuation for emerging market stocks gives investors a margin of safety when investing and also leaves more room on the table for future upside.
Furthermore, while U.S. stocks have outperformed emerging stocks over the past decade, this doesn’t mean that this will always be the case. In fact, for the decade spanning 2000 to 2010, emerging market stocks vastly outperformed the returns of both U.S. stocks and other international, developed-market stocks.
While it may not be today or tomorrow, at some point, some reversion to the mean seems inevitable, and we could again see emerging market stocks outperform again at some point, making it worth having exposure to them with a vehicle like EEM.
Below, you’ll find a performance chart showing the divergence between U.S. stocks, represented by the SPDR S&P 500 ETF (NYSEARCA:SPY), and EEM using TipRanks’ ETF Comparison Tool. Not only does this screener help you to compare the performance of up to 20 stocks or ETFs at a time, but you can also use it to gather other data on each ETF, like expense ratios, assets under management, and TipRanks Smart Scores.
Lastly, a final benefit of investing in an ETF like EEM is that investing outside of one’s home market helps investors to spread out their risk.
EEM Sports 1,199 Holdings
With 1,199 holdings across large-cap and mid-cap emerging market stocks, EEM offers investors ample diversification. Furthermore, EEM’s top 10 holdings account for just 23.2% of assets, so this isn’t one of the ETFs that hold many stocks but is dominated by just a handful of positions.
EEM is also diversified across industries — while many of the top holdings like Taiwan Semiconductor (NYSE:TSM), Tencent (OTC:TCEHY), Samsung (OTC:SSMMF), and Alibaba (NYSE:BABA) all fall under the technology sector, other top 10 holdings include Brazilian miner Vale (NYSE:VALE) and Indian conglomerate Reliance Industries. Top holding Taiwan Semiconductor has a large weighting here at 6.7%, but remember that Taiwan Semiconductor is the ninth-largest company in the world by market cap (as of September 2022), so it will occupy a large position in any emerging market index.
The financial sector is the most prominent one among EEM’s holdings, with a 21% weighting. Further, information technology and consumer discretionary make up 20.2% and 13.4% of the fund’s holdings, respectively. The communications sector makes up 10.5% of the fund, and all other sectors account for single-digit percentage allocations.
EEM stock also offers plenty of geographical diversification. China accounts for 32.3% of holdings, while India, Taiwan, and South Korea all account for double-digit allocations as well. China has a large weighting here, but China is by far the largest emerging market economy (and the second largest economy in the world), so this makes sense.
Other countries represented include Brazil (with a 4.8% weighting), Saudi Arabia (4%), South Africa (3.5%), Mexico (2.6%), Thailand (2.1%), and Indonesia (1.9%). All other emerging markets make up the rest of the fund’s assets.
The 2.5% Dividend Adds to Its Appeal
In addition to this strong diversification, the iShares MSCI Emerging Markets ETF also features a 2.5% dividend yield. While this isn’t a remarkable yield, it helps to add to total returns over time. The ETF has paid out a dividend for 17 consecutive years. U.S. investors should note that EEM pays a semiannual dividend (twice a year, typically in June and December) rather than the quarterly payout schedule of most domestic stocks.
In terms of negatives, EEM’s expense ratio of 0.69% is a bit higher than I would expect for a broad-market, index-based ETF like this, especially since BlackRock’s series of iShares ETFs are typically known for their low fees. For reference, the SPY ETF has a 0.09% expense ratio.
The other negative to note here is that this ETF has underperformed indices like the S&P 500 over the past decade, so it doesn’t have the pedigree of a long-term winner. However, as discussed above, this is because emerging markets themselves have underperformed the U.S. market for the past decade, and I would expect that the situation will revert to the mean at some point in the future.
Ultimately, EEM is a useful tool that investors can utilize to instantly gain exposure to a broad swath of emerging market stocks, which I think all U.S-based and developed market-based investors should consider having some long-term exposure to.