Most Investors Can Do a Lot Better Than Buying the EEM ETF

The iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) turned 16 years old earlier this month, underscoring the fund’s lengthy run as one of the preeminent emerging markets exchange traded funds (ETFs) listed in the U.S. For years, the EEM ETF was widely viewed as the premier emerging markets ETF available to U.S. investors, but that has changed.

eem etf

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While actively managed mutual funds had long made international stocks accessible to U.S. investors, those funds often did so with high fees and sub-par long-term performance.

EEM flipped that script by providing exposure to a slew of fast-growing developing economies under the umbrella of a single, passively managed ETF that, by the standards of 2003 when EEM debuted, was attractively priced.

EEM ETF: A Brief Backstory

As an early player EEM had a sizable head start on many rival emerging markets ETFs. EEM has enjoyed some other advantages over its lifetime. The fund tracks the MSCI Emerging Markets Index, easily the world’s most widely observed gauge of emerging markets equities.

As the ETF industry has grown, so has the importance of brand recognition. As the world’s largest ETF sponsor, BlackRock Inc.’s (NYSE:BLK) iShares has brand awareness in the ETF realm that is comparable to an Apple or Coca-Cola in the non-investment world. Said another way, the combination of EEM being an iShares fund and tracking the venerable MSCI Emerging Markets Index coupled with its first-mover advantage speak to EEM having enjoyed significant marketing advantages over the course of its lifespan.

EEM ETF: Still Royalty, but Not King

As of April 17, EEM had nearly $36 billion in assets under management, still good for one of the largest totals among diversified emerging markets ETFs, but nowhere close to being the largest emerging markets ETF.

In terms of sheer heft, EEM has been usurped by the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO) and the iShares Core MSCI Emerging Markets ETF (NYSEARCA:IEMG). VWO and IEMG have $66 billion and $61.40 billion, respectively, in assets under management.

The primary reason EEM long ago ceded the top spot among emerging markets ETFs is its annual fee. EEM charges 0.67% per year, or $67 on a $10,000 investment. Back in the early days of the ETF business, that was an attractive fee for an emerging markets fund. These days, not so much. VWO charges just 0.12% per year while IEMG charges 0.14%.

Rather than lower EEM’s fee to compete with VWO, BlackRock introduced IEMG in October 2012 as a cost-effective alternative to EEM for fee-conscious advisors and buy-and-hold investors. The strategy clearly worked as IEMG is not even seven years old and today is the second-largest emerging markets ETF in the U.S.

None of this means EEM is not useful. Quite the contrary. For professional investors looking for short- to medium-term exposure to emerging markets, EEM is the go-to ETF. The fund is one of the most heavily traded international ETFs in the U.S., is highly liquid, features tight bid/ask spreads and functions as the premier price discovery method for U.S. traders because the major geographic exposures in EEM are closed when U.S. financial markets are open.

Bottom Line on the EEM ETF

Changes are looming for EEM. Earlier this year, MSCI announced plans to increase the weight of China A-shares, the stocks trading on mainland China, in its international indexes. That means EEM’s already sizable weight to China (currently just over 33%) will increase.

Additionally, Argentina and Saudi Arabia will be joining the MSCI Emerging Markets Index later this year. In the case of Saudi Arabia, stocks from that country are expected to garner 2.60% of the index, meaning EEM’s weight to that country will be roughly the same as what the fund devotes to Mexican stocks.

Going forward, EEM is likely to remain the preferred emerging markets fund for institutional investors and other pros, but for regular investors, lower fee options, such as IEMG and VWO, are more appropriate than EEM.

Todd Shriber owns shares of VWO.

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