E Best Long-Term Performance Diversified Emerging Markets ETFs

The iShares MSCI Emerging Markets ETF (EEM) is the largest and one of the oldest available ETFs in the Emerging Markets asset class. It was launched on April 7, 2003. Since then, EEM has had a compounded rate of return of 10.39%. An S&P 500 index fund returned 9.44% CAGR over the same period. This outperformance came with a price though, and that price is called volatility. In the case of EEM, it’s standard deviation (a measure of volatility) was 21.97% while the S&P 500 was only 13.38% (lower means less volatility). Other ways to demonstrate how this volatility (risk) relates to performance (reward) are the Sharpe & Sortino ratios. Typically, the higher these ratios are, the better the risk vs reward ratio.

In the chart below, the S&P 500 funds’ Sharpe & Sortino ratios are both higher than EEM. So, with all this additional risk, why should long-term investors consider allocating part of their equity portfolio to Diversified Emerging Markets? My answer is diversification. Diversification has oft been quoted as the “only free lunch in investing”. As a long-term investor and an investment blogger, I have made it my mission to find and invest in as many different equity asset classes as possible without degrading long-term performance. It is my opinion that Diversified Emerging Market funds are a useful component of a worldwide equity portfolio because they have the potential to lift long-term performance while simultaneously reducing overall risk. The risk reduction can be found in this asset class’ correlation to U.S. Markets. Again referring at the chart below, EEM had a correlation to U.S. Markets of 0.79. This is a favorable number because the lower the number, the lower the correlation to U.S. Markets, that is, if the asset class does not perform poorly long-term.

EEM vs S&P 500 index fund: May 2003 – March 2019

Source: portfoliovisualizer.com/

EEM vs SPY: April 11, 2003 – April 21, 2019

Source: koyfin.com/home

Since the ETF product is much younger than the mutual fund industry, let’s look at how an older Emerging Markets index mutual fund has performed for 20 years. EEM has been available for 16 years, but most long-term investors would prefer to see a 20-year timeframe, since we may be holding one of these funds in our portfolio for decades. For the 20-year back-test I have chosen the Vanguard Emerging Markets Stock Index Fund Investor Shares (VEIEX). In the chart below, you can see that VEIEX had similar volatility as EEM and about the same correlation to U.S. Markets, but the Sharpe & Sortino ratios did improve for the 20-year period.

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Disclosures: We currently own shares of DGS & DEM, and we intend to purchase more shares in the future. I am not a professional investment advisor. Please perform you own due diligence or seek ...

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Alpha Stockman 2 years ago Member's comment

Impressive.

Micah H. McDonald 2 years ago Author's comment

Thank you Alpha. I appreciate that very much. This is my first article for TalkMarkets. Micah.

Alpha Stockman 2 years ago Member's comment

Welcome, looking forward to reading more by you - I've added you to my follow list.

Micah H. McDonald 2 years ago Author's comment

Thank you.