Looking at the carnage yesterday, the one aspect of the trade that stood out was the lack of damage to the two emerging markets ETFs, Vanguard FTSE Emerging Markets Index Fund ETF (NYSE:VWO) and iShares MSCI Emerging Markets ETF (NYSE:EEM). The VWO fell -0.30% on Wednesday and the EEM, fell 19 bp’s, far less than the carnage on the NYSE, with the Russell 2000 down over 3%, the NASDAQ down 1.55%, and the S&P 500 down 1.75%.
Client portfolios have changed very little since the COVID-19 melt-down started, since clients' largest overweight was Tech to start with, but both Financials and Emerging Markets have been very poor choices.
Clients remain long both sectors, but it was time for a brief update on Emerging Markets and non-US for readers just to be upfront about the positions:
YTD returns:
- VWO: -18.42%, and 10-yr return is 1.50%
- EEM: -18.74%, and 10-yr return is 1.06%
- OAKIX: -34.55% and 10-yr return is 2.59%
(Return data per Morningstar as of 5/13/20)
A reader asked why own both VWO and EEM, and it was a good question. The top 5-6 holdings are almost identical at 20% of each ETF, but there are structured differences between the two, such as the trading volume on EEM, which trades mores shares on a daily basis, than VWO. Clients have been gradually transitioned over to Vanguard’s VWO since the expense ratio is just 10 bps. There are many ways to measure the “cost” of an ETF, and EEM’s bid / ask spread is tighter than the VWO, but these positions are not traded frequently, if at all, so it’s a longer-term buy-and-hold allocation.
Emerging Markets were avoided completely for clients, even during the early to mid 2000s, until early 2016, when PIMCO made their “Trade of the Decade” call here, the problem was that clients were bought just a 2%-3% weight in the EM class at the time. In 2017, Emerging Markets rose 40% on a weak dollar, far outperforming the S&P 500’s 21%-22% that year.
2017 was the last year EMs have seen any decent relative performance to the S&P 500.
In 2018, more was added to the EM class and clients saw the Oakmark International Fund (OAKIX) added to their accounts, with the asset class lifted to 6%-10% of equity exposure.
And it’s pretty much been bad news since.
The trade war last year and the rhetoric between China and the US hasn’t helped EMs since a robust Chinese economy was a substantial part of non-US growth between 2003 and 2007 when the Chinese economy was growing 15%-16% per year. However, Chinese GDP growth has decline steadily since President Trump and the trade rhetoric and now with COVID-19 it will only get worse.
China is going to get stuck with ownership of COVID-19, whether that is right or wrong, so as an “Emerging Market” it will have an impact on the asset class.
Oakmark International is another story entirely. David Herro is a world-class manager, but the weight in the European banks both with Brexit, and then China trade and now COVID-19, it’s been one nightmare scenario after another. Not only has the OAKIX fallen 34% YTD, but David's peer group ranking is now in the 100th percentile, meaning that of the 744 funds in his category, Oakmark International is at the bottom “relatively” speaking.
Small amounts are being added to OAKIX presently. Not to pile on to Oakmark or Herro, but it’s hard to sell one of the worst-performing funds in one of the worst performing asset classes YTD and think it’s a smart move.
Summary / conclusion: The real appeal for me personally for clients is the 10-year, “average, annual” return of the Emerging Markets asset class. The 10-year average annual return for the SPDR S&P 500 (NYSE:SPY) as of today, is 11.5% so there is quite a return disparity over time between the two asset classes.
The dollar continues strong even after the start of COVID-19 since the swap lines that Jay Powell and the Fed instituted have driven a strong demand for dollars by foreign central banks. I dont know the particulars of the actual transmission policy, but this demand is apparently one factor in keeping the dollar up near 100 (DXY).
The dollar has been stronger since early 2018. We made a timely call on the dollar (relative to emerging markets) here, and I would have expected it to weaken more by now.
Clients are keeping their emerging markets allocation for now. But it hasn’t been enjoyable.
Take all opinions and forecasts with substantial skepticism. Forecasts and opinions can change tomorrow.