With Emerging Market ETFs Rising, Remember the Differences (VWO, EEM)

International stocks and their corresponding EFTs in both developed and emerging markets are crushing their U.S. counterparts this year.

Year-to-date, the widely followed MSCI EAFE Index and the MSCI Emerging Markets Index are up 19.1% and 15.8%, respectively. The S&P 500 is higher by “just” 9.6%. Predictably, this is prompting investors to pour billions of dollars of capital into international ETFs.

“The same old performance chase is now at work. Animal spirits are shifting their focus from the S&P 500 to Europe, Japan and the Emerging Markets, where the gains are becoming larger and more rapid. Same thing we always see,” said The Reformed Broker Josh Brown.

Investors considering emerging markets ETFs, such as the Vanguard FTSE Emerging Markets ETF (VWO) and the iShares MSCI Emerging Markets ETF (EEM), and data suggest investors are indeed allocating to these funds, need to remember some marquee differences between these products. It is prosaic advice, but worth remembering nonetheless: Simply because VWO and EEM are emerging markets ETFs does not mean they are twins.

Far from it in fact. Several years, Vanguard dropped the MSCI Emerging Markets as VWO's benchmark, opting for an index from FTSE Russell. Today, VWO, the largest emerging markets ETF by assets, tracks the FTSE Emerging Markets All Cap China A Inclusion Index. What that means is that for some time, VWO has been incrementally adding exposure to A-shares, the stocks trading on mainland China.

On the other hand, EEM and other funds benchmarked to the MSCI Emerging Markets Index are still waiting for MSCI to rule on the fate of A-shares in its international indexes, a decision that is expected later this month.

That is not the only big difference between EEM and VWO. MSCI considers South Korea an emerging market and even removed Asia's fourth-largest economy from its list for possible promotion to developed market status. FTSE Russell classifies South Korea as a developed market, meaning VWO features no exposure to South Korean equities. EEM allocates 15.5% of its weight to South Korea.

With South Korean stocks performing well this year, that is a contributing factor behind EEM's year-to-date advantage of almost 400 basis points over VWO.

One advantage VWO has is fees. VWO's annual fee is just 0.14%, putting it more in competition with the increasingly popular iShares Core MSCI Emerging Markets ETF (IEMG). IEMG, EEM's low-cost alternative, also charges 0.14% per year and is one of this year's top asset-gathering ETFs.

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