As individual investors, we are always careful of what we invest in and what investing vehicle we use. We try to filter the business media noise or recommendations from analyst or fund house marketing data. In last few years, we have been told that the simple and easiest way to invest in new growing emerging markets is use emerging market ETFs and/or funds. There are so many different funds with so many different themes that we should understand whether we are really getting what we are looking for. Following are few examples as observations on structures of ETFs.
Example 1: VWO and EEM are funds based on MSCI emerging market select index which is market capitalization based index. It includes 18 to 20 emerging economies where stocks can be bought free of any restrictions.
- VWO has 60% of assets invested in 130 stocks (all in native countries), while EEM’s 60% assets are in only 42 corporations (approximately 29 in ADR/GDRs).
- VWO is invested in 784 stocks with expense ratio of 0.24%, while EEM is invested in only 342 securities with expense ratio of 0.72%.
- If both are based on same index, why are these funds so different? EEM goes the easy route of investing in ADRs/GDRs, less number of corporations, and still has three times the expenses?
Example 2: BIK is fund for BRIC markets. BIK is invested in only 40 companies distributed in four countries. Of which 54% of its assets are in only 10 companies. The fund still has an expense ratio of 0.4%. Emerging economies has combined GDP of about USD 10trillion or more, and this fund picks only 40 companies to represent this. Does that make sense?
Example 3: BKF is market capitalization based index fund designed to follow MSCI’s BRIC Index. It is designed to focus only on four BRIC countries.
- BKF is invested 176 corporations out of which 34 are in the form of ADR/GDR.
- Approximately 60% of its assets are invested in only 23 corporations. With such a high concentrated position in only four countries and 23 corporations, I do not understand the rationale for expense ratio of 0.72%.
Example 4: Four funds IIF, IFN, PIN, INP, and EPI have somewhat similar objective to track performance of Indian Corporations. Each has a different method on how they execute it.
- Funds expenses are IIF (1.40%), IFN (1.18%), INP (0.89%), EPI (0.88%), and PIN (0.78%).
- Funds IIF, INP, and PIN have more than 50% investments in top 10, IFN is close of 50%. The fund with highest expenses, i.e. IIF, has approx. 62% invested in top 10. Fund EPI has 46% invested in top 10, with almost 17% allocation to just one corporation.
- After such a high fees and varied executions methods, these funds could find only seven specific corporations (in 4 funds or more), four corporations (in 2 or more), only 10 corporations (in one fund only). To put this into perspective, on India’s Bombay Stock Exchange, there were 7500 listed equities (in 2006), 7706 equities (in 2007), 7821 equities (in 2008), and 7784 equities (in 2009). The exchange’s index, known as SENSEX, itself has 30 companies on its roll. In short, with all the expertise these funds have, they could only find 21 companies of which more than 10 are common occurrences.
A general observation here is we need to really understand what we are buying. These examples show that every fund is not what we think they are.
