There are better alternatives.

fundcoverage@morningstar.comEEM
by Daniel Sotiroff
4/2/2019
iShares MSCI Emerging Markets

IShares MSCI Emerging Markets ETF EEM isn’t a compelling way to invest in emerging-markets stocks. The strategy reasonably represents the emerging-markets universe, but its expense ratio isn’t competitive with similar index-tracking alternatives. It warrants a Morningstar Analyst Rating of Neutral.

This fund tracks the MSCI Emerging Markets Index and includes large- and mid-cap stocks from 24 developing nations. Its market-cap-weighted approach benefits investors by capturing the market’s collective opinion of each stock’s value while mitigating turnover and trading costs. Markets usually get long-term prices correct, but they occasionally make mistakes. Investors can drive valuations up if they get excited about a particular area of the market, and market-cap weighting will increase the fund’s exposure to it.

The portfolio reasonably diversifies stock-specific risks, which should mitigate the impact of the worst-performing firms. It holds almost 1,000 names while its 10 largest positions account for 24% of its assets. It also provides greater exposure to a narrow segment of the emerging-markets universe. Up until several years ago, locally traded Chinese stocks, or A-shares, were difficult for retail investors to hold owing to restrictions imposed by the Chinese government. But these restrictions have loosened over time, and the fund had just under 1% of its assets in China A-shares as of March 2019.

Differences in country composition can cause the fund’s performance to deviate from its peers. Stocks listed in China make up just under a third of the portfolio, compared with 26% for the diversified emerging-markets Morningstar Category average.

The fund beat the category average by 34 basis points annually over the trailing five years through March 2019. However, its hefty 0.67% expense ratio affected its performance relative to other index-tracking funds in the category. Its total return lagged iShares Core MSCI Emerging Markets ETF IEMG (0.14% expense ratio) by 41 basis points annually over this period.



Portfolio Construction

This portfolio captures the composition of the emerging-markets equity universe. But it does not control its regional exposure, which compromises its geographic diversification and warrants a Neutral Process Pillar rating. The managers use full replication to tracks the MSCI Emerging Markets Index, which covers large- and mid-cap stocks from 24 emerging markets. It sorts stocks by their free-float-adjusted market capitalization and targets those that rank in the top 85% by market cap. The index uses buffering rules around this cutoff point to help mitigate excessive turnover and applies additional liquidity screens that make the final index easier to track. The benchmark weights its holdings by market cap, which helps mitigate turnover and any related trading costs. It reconstitutes semiannually in May and November.

Fees

This is one of the most expensive index-tracking funds in the diversified emerging-markets category, so it earns a Neutral Price Pillar rating. BlackRock levies a 0.67% expense ratio for this fund, while many of its index-tracking competitors charge a fraction of that amount. The fund’s total returns have lagged its target index by 0.65% annually over the trailing three years through March 2019, a gap that was comparable to its expense ratio.

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