Morningstar Advisor - December 2013/January 2014 - (Page 47)

Malaysia, and Turkey, and underweight companies from China, Brazil, India, and Russia. These country tilts are somewhat driven by the availability of investable, dividend-paying small caps in each country. Funds at a Glance AUM US$ bil Expense Ratio 5-Yr Std Dev 5-Yr Sortino R. Avg Mkt Cap US$ bil WisdomTree EM SmCap DGS 2.8 0.25% 25.0% 0.92 1.3 As for sector exposures, this fund has greater exposure to industrial and consumer firms and less exposure to financials and energy firms relative to the MSCI Emerging Markets Index. Also, while cap-weighted, small-cap funds often have high turnover as securities move out of specified market-cap thresholds, This fund's dividend approach has resulted in lower turnover during its annual reconstitution in June. This is particularly important in an asset class with relatively lower liquidity. iShares MSCI EM Min Vol EEMV* 1.8 0.63% 20.7% 1.04 10.3 MSCI EM Index - - 26.4% 0.59 19.0 IShares MSCI Emerging Markets Minimum In U.S. equities, the outperformance of low-volatility strategies can be partially attributed to the value and small-cap effect. However, in emerging markets, low-volatility strategies have less of a value and smallcap tilt. The iShares and PowerShares funds have average market caps of around $10 billion versus $20 billion for the MSCI index. That is partly due to the fact that low-volatility portfolios have relatively less exposure to the government-controlled mega-cap stocks. Volatility EEMV The 2008 financial crisis and its lingering fallout have created interest in low-volatility strategies that are designed to minimize dramatic ups and downs in performance. Two ETFs that offer low-volatility emerging-markets equity exposure are iShares MSCI Emerging Markets Minimum Volatility and PowerShares S&P Emerging Markets Low Volatility EELV. As their names imply, these funds' indexes have exhibited lower volatility (with annualized standard deviations around 20%) over the past five years relative to the MSCI Emerging Markets Index (26%). Thanks in part to the heterogeneity of the emerging-markets equity asset class, low-volatility strategies result in greater volatility reduction relative to a cap-weighted index when compared with low-volatility strategies in U.S. equities. This is especially important in emerging markets, as volatility drag can have an impact on long-term performance. The reduced volatility has helped the funds' benchmarks avoid big losses. In 2008, the iShares and PowerShares underlying indexes declined 42% and 34%, respectively, versus the MSCI Emerging Markets Index's 53% decline. These indexes exhibited relatively Funds Data as of Sept. 30, 2013 * Historical data is index data, as inception of EEMV was Oct. 18, 2011 muted declines again in 2011, when the cap-weighted index stumbled. Those two years are key drivers of the low-volatility strategies' outperformance the past five years. These strategies can have high turnover and can include securities that are not that liquid. With higher transaction expenses in emerging markets, a low-volatility index without appropriate liquidity and investment screens could be very costly to replicate and drag on the performance of the fund relative to its index. We note that both of the indexes were created after the global financial crisis, so longerterm historical data reflect hypothetical performance. Investors should consider funds that track an index by a provider with an established track record in emerging markets. In that regard, we prefer the iShares fund, which tracks an MSCI index, over the PowerShares fund, which tracks an S&P index. MSCI incorporates a number of investability screens to its indexes, and it is the index provider of choice for institutional investors in emerging markets. Both funds are about two years old, and since inception the iShares fund has tracked its MSCI index more closely than the PowerShares fund has tracked its S&P index. That suggests that the MSCI index may be a more investable index. The iShares fund is reconstituted twice a year in May and November. The index it tracks is a minimum variance portfolio of 200 holdings culled from the MSCI Emerging Markets Index. The iShares fund has heavy weightings in Taiwan, China, and South Korea, and in financials, consumer staples, and telecoms. The index has constraints to limit turnover and to ensure country and sector diversification, so we do not expect this fund's portfolio to change significantly during its semiannual reconstitution or exhibit very high turnover. S&P addressed the performance lag issue one year after the PowerShares fund launched by introducing a liquidity threshold to the index to improve its investability. While the fund has subsequently exhibited much better tracking, we think this type of index tweaking suggests that the index was initially created without acknowledging some of the unique issues related to investing in emerging markets. K Patricia Oey is a senior fund analyst on the passive funds research team with Morningstar. MorningstarAdvisor.com 47 http://www.MorningstarAdvisor.com

Table of Contents for the Digital Edition of Morningstar Advisor - December 2013/January 2014

Morningstar Advisor - December 2013/January 2014
Contents
Contributors
Letter From the Editor
What’s Your Purpose?
Working for Gen Y
How to Allocate College Savings
Mobius Looks to a New Frontier
Investments á la Carte
Investment Briefs
How to Manage Bonds for Today and Tomorrow
Cloud Is the New Engine of Growth
Knowing Where to Look
Economic Vulnerability Varies by Country
Factor Investing in Emerging Markets
Following the Rules
Exploring Indexing’s Next Frontiers
Frequent Fliers
Family Blind Spots
Optimal Portfolios for the Long Run
Finding Value in a Pricey Sector
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Emerging-Markets Roller Coaster

Morningstar Advisor - December 2013/January 2014