A Smart Beta Emerging Markets Idea for 2018

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2017-11-29 03:19:00

The MSCI Emerging Markets Index is up about 35% year-to-date, but that impressive performance is not preventing some market observers from forecasting more gains for emerging markets equities in 2018. In fact, plenty of big-name investment banks and money managers expect 2018 to be another banner year for stocks in developing economies.

With cap-weighted emerging markets benchmarks having performed well this year, investors may want to consider a smart beta approach in 2018 as a way of lowering risk and focusing on quality and value in developing economies. The JPMorgan Diversified Return Emerging Markets Equity ETF (JPEM) is one of the exchange traded funds (ETFs) that uses a smart beta approach to emerging markets equities.

JPEM, which is up about 26% year-to-date while residing around record highs, “tracks an index that aims to deliver higher risk-adjusted returns than a traditional market cap-weighted index through broad diversification of risk across regions and sectors,” according to J.P. Morgan Asset Management.

JPEM is a multi-factor ETF that emphasizes investment factors such as quality, value and positive price momentum. The ETF tracks an index constructed by FTSE Russell. That index provider does not classify South Korea as an emerging market, meaning JPEM has a different look at the geographic level than do competing funds that track MSCI benchmarks.

After the stellar showing by emerging markets stocks in 2017, the premise behind JPEM could reward investors that arrived late to emerging equities or are just now revisiting the asset class. While this year’s emerging markets resurgence has been mostly broad-based, emphasizing quality and value after 2017’s surge could be good ideas for pragmatic investors.

A significant part of the thesis for emerging markets stocks has been that they offer value relative to the U.S. Indeed, the MSCI Emerging Markets Index trades at a significant discount to the S&P 500. JPEM reflects the emerging markets value proposition as well. At the end of the third quarter, the ETF had a price-to-book ratio of 1.84 and a price-to-earnings ratio of 13.5, both significantly below the comparable metrics on U.S. equity indexes.

Improving margins, decreasing financial leverage and accomodative central banks (only one emerging market has raised interest rates this year) are among the factors expected to boost developing markets equities in 2018.

“Despite a sharp rally over the past year, the outlook continues to be positive for emerging market equities with domestic economic momentum building and improving credit growth,” according to J.P. Morgan Asset Management.

 



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