This Vanguard ETF Navigates Emerging Markets with a Low-Cost Strategy

Faithful representation of the market at a low price tag.

Lan Anh Tran 10 May, 2024 | 4:52AM
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A photograph featuring a Vanguard's logo sign outside its headquarter in Malvern, Pennsylvania.

Key Morningstar Metrics for Vanguard FTSE Emerging Markets ETF

Morningstar Medalist Rating: Bronze
Process Pillar: Average
People Pillar: Above Average
Parent Pillar: High

Vanguard FTSE Emerging Markets ETF VWO provides a broad portfolio of emerging-markets stocks at rock-bottom fees, but investors should be aware of lingering geopolitical risks.

The ETF tracks the FTSE Emerging Markets All Cap China A Inclusion Index, which includes a broad swath of stocks from more than 20 emerging economies. It excludes Korean stocks because FTSE classifies South Korea as a developed market. The ETF’s market-cap-weighted approach benefits investors by capturing the market’s collective opinion of each stock’s value while mitigating turnover and trading costs. Occasionally it will increase the fund’s exposure to expensive stocks when investors get excited about a market, but that doesn’t undermine its long-term efficacy. The ETF employs a buffer around the smallest stocks to limit excessive trading in these positions, which can be costly.

The portfolio’s extensive diversification mitigates the impact of the worst-performing positions. As of December 2023, it held over 4,700 stocks, and its 10 largest positions accounted for less than 18% of its assets. The ETF switched to its current benchmark in 2016 and has provided exposure to locally traded China A-shares since then, further expanding its reach.

Chinese stocks accounted for more than 28% of this portfolio as of December 2023. While this represents the relative size and importance of the Chinese equity market, it could also expose the ETF to country-specific risk.

In general, emerging markets face greater geopolitical risks than their developed counterparts. The recent Russia-Ukraine conflict highlights such risk. Shortly after the invasion, FTSE removed Russian stocks from the ETF’s target index and the ETF marked its Russian allocation down to zero. Russian stocks represented less than 3% of the ETF’s assets at the end of January 2022, so the impact on performance was somewhat muted.

This is one of the least expensive funds in the category, and the ultralow price tag should provide a durable advantage.

Vanguard FTSE Emerging Markets ETF: Performance Highlights

The ETF modestly outperformed the average peer in its diversified emerging-markets Morningstar Category by 38 basis points annualized from its 2005 inception through January 2024. The fund’s risk-adjusted performance is comparable with the average category peer over this period.

Country and regional exposure has been and will continue to be crucial for this Vanguard FTSE Emerging Markets’ performance. Its relatively higher allocation to China and Taiwan performed well over the past decade as these markets soared. However, it did not escape the recent meltdown in emerging-markets stocks. The ETF lagged its category average by 4.45 percentage points between July 2022 and June 2023. Its heavy stake in emerging Asian markets disappointed in this period, particularly its positions in Chinese stocks. It also treaded lightly on better-performing Latin American markets. Underweighting emerging European markets briefly helped the ETF’s returns in the first half of 2022 as these economies suffered from geopolitical turmoil in the region.

Moving forward, Vanguard FTSE Emerging Markets’ largest country exposure will continue to influence its category-relative performance. Active category peers might be able to leverage stock selection to better weather volatile periods. Nonetheless, the fund’s broad scope cushioned the magnitude of its underperformance.

 

The author or authors do not own shares in any securities mentioned in this article.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Vanguard FTSE Emerging Markets ETF44.89 USD0.72Rating

About Author

Lan Anh Tran  Associate manager research analyst for Morningstar.

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