3 Ways to Tap Emerging Markets

We’ve all heard the call of China in recent years. Its economy is a subject unto itself. The country has 160 cities with a population of 1 million or more, 12 of which have at least 5 million inhabitants. The investment allure of its rising middle class is obvious.

But what about investors that want to include other emerging markets like Brazil, Russia and India? What does an investor do to spread his or her risk while still reaping the potential booming benefits? Well, you could buy into a BRIC-specific exchange-traded fund, but that might not be diversified enough.

The solution is the MSCI Emerging Markets Index. In existence since 1988, the index represents approximately 14% of the global equity opportunity. If you’re a growth investor, this is where you want to be.

The index itself — created by MSCI Inc. (NYSE:MSCI) — covers 2,700 securities in 21 markets, including the BRIC nations. Its universe of stocks covers everything from large caps to small caps, value to growth and every possible sector.

In June each year, MSCI evaluates each country currently included as well as potential additions, assessing the economic development, size and market accessibility before setting the list. As you can imagine, any additions or deletions of countries would significantly change the portfolio. In June 2011, it chose to keep Korea and Taiwan in the emerging markets index instead of moving to the MSCI EAFE, which is for developed markets. Next June, it’s very possible that those two countries will join the MSCI EAFE. Clearly, any changes are well studied before being initiated, meaning you can count on a reliable, although sometimes volatile, index.

In my previous article about the MSCI EAFE, I covered three ETFs, including one that was equal-weighted, rather than market-weighted. Today, we’ll look at another three funds, but with a slight twist. In addition to a market-weighted fund and an equal-weighted fund, I’ll look at a third fund based on an emerging markets index, just not the MSCI version.

Vanguard MSCI Emerging Markets ETF

When it comes to market-weighted funds, the Vanguard MSCI Emerging Markets ETF (NYSE:VWO) is the better choice given its expense ratio of 0.22% is one-third iShares’ MSCI Emerging Markets Index Fund (NYSE:EEM) at 0.69%. While EEM is older by two years, VWO has almost $13 billion more in assets under management. Interestingly, the EEM’s average daily volume is 160% of its total net assets, which indicates it’s used by day traders as much as long-term investors. Since the U.S. has some of the lowest management fees in the world, it seems excessive for BlackRock (NYSE:BLK) to be charging almost three-quarters of a percent for the same service Vanguard provides.

Rydex MSCI Emerging Markets Equal Weight ETF

On the equal-weighted side of the ledger, we go back to Rydex SGI with the Rydex MSCI Emerging Markets Equal Weight ETF (NYSE:EWEM), which tracks the performance of the MSCI Emerging Markets Equal Weight Index, hence the name. Although the expense ratio is high at 0.77%, at least with the Rydex fund you have an opportunity to outperform the EEM and VWO. That’s because the equal-weight index rebalances quarterly, both capitalizing on gains realized and providing buying opportunities where stocks have fallen in price.

Like the MSCI EAFE Equal Weight Index, which has outperformed the market weighted version, so too has the MSCI Emerging Markets Equal Weight Index. Since Jan. 31, 2008, the equal weight index has outperformed the market-weighted index by almost 500 basis points annually. If low expense ratios aren’t an absolute must, EWEM is an excellent alternative.

WisdomTree Emerging Markets Equity Income Fund

An interesting third fund is the WisdomTree Emerging Markets Equity Income Fund (NYSE:DEM), which is based on the WisdomTree Emerging Markets Equity Income Index. The index is a fundamentally weighted index that measures the performance of the highest-yielding stocks selected from the WisdomTree Emerging Markets Dividend Index. The top 30% in terms of dividend yield make it into the equity income index.

The fund’s SEC 30-day yield is a nifty 7.41%, which certainly will catch the attention of income investors. Since DEM’s inception in July 2007, the average annual return of its stock price to the end of December 2011 is 3.84%, about 650 basis points higher than the MSCI Emerging Markets Index. While it traded at a discount to net asset value for most of its young life, it now trades at a premium. Morningstar gives it a five-star rating despite a 0.63% expense ratio. If you like dividends, this is the way to go in emerging markets.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.