Presentation of the IEMG
iShares Core MSCI Emerging Markets ETF (NYSEARCA: IEMG) is an exchange-traded fund offering investors exposure to “a broad range of emerging market companies”. The fund’s inception date was October 18, 2021.
IEMG invests in accordance with its benchmark, the MSCI Emerging Markets Investable Market Index. As of January 14, 2022, IEMG’s portfolio consisted of 2,578 holdings, with total assets under management of $78.46 billion, reflecting the high popularity of the fund. The expenditure rate is reported by iShares as 0.11%, which is cheaper if we compare IEMG to iShares’ other macro ETF products.
IEMG Recent Fund Flows
Over the past year, IEMG has benefited from approximately $9.4 billion in fund flows (see data below).
Fund flows have been largely strong and stable. Reasonably strong demand would perhaps suggest a search for yield among US investors in particular, as investments in “emerging markets” are generally associated with higher return and risk. However, although demand was strong, IEMG’s share price (i.e. excluding dividends) did not beat the SPDR S&P 500 Trust ETF (SPY), a popular US-designed ETF to track the performance of the popular US equity benchmark, the S&P 500.
An underperformance of around 20-25% since the start of 2021 (so far) is significant, and while IEMG’s dividend yield (based on 30-day SEC yield) is higher than of SPY, the difference (currently about 2% against about 1.15% for TO SPY) is not enough in favor of IEMG to inhibit this kind of price underperformance. Nevertheless, IEMG managed to outperform SPY over some time periods (e.g. 2017 and the second half of 2020). However, these periods of favorable deviations seem to be short-lived, so the IEMG has proven (at least in the past) to be quite a speculative instrument/strategy.
IEMG country and sector positioning
IEMG’s country exposures are presented in the graph below, which shows that IEMG has the most exposure to China (29%), Taiwan (17%), India (14%) and South Korea (13%). South Korea is a more developed economy, India is less developed, while China and Taiwan remain somewhat “entangled” in a spat in progress in relation to Taiwan independence. China is also ruled by the Chinese Communist Party (CCP), whose political and economic ideologies understandably make China a riskier territory for Western capitalists.
In terms of sector exposures, IEMG has the highest exposure to stocks of information technology (22%), financial services (19%), consumer discretionary (13%), communication (10%) and materials (9%). These sectors together represent approximately 73% of the fund (as of January 13, 2022).
Based on IEMG’s sector exposures, we could infer that the fund’s broader theme relates to economic sensitivity; Technology, financials and consumer (discretionary) stocks are sensitive to broader economic trends. One issue here is that China is (supported by Fidelity research) likely in an economic contraction phase right now (as of Q4 2021).
So while IEMG has rallied against broader markets very recently in 2022, the fund is arguably not very well positioned economically. We could relate this to the IEMG share price expressed this time in nominal terms (and not relative to SPY). The graph below shows that despite decent entries, IEMG has slowed down. Markets may be leading rather than lagging economic trends, but markets and economies will likely be on the move (one sometimes leading the other and vice versa).
One could say that the fund is more oriented towards “growth” than “value” themes, but there is no particular bias, financials being often considered as a value-oriented sector (more mature and lower growth) for example.
IEMG Portfolio Concentration and Volatility
IEMG’s top 10 holdings are illustrated below using recent data from iShares. The top 10 accounted for around 22% of the fund as of January 13, 2022, which is not particularly high, especially when compared to funds from a single country.
This fairly reasonable level of concentration is likely helping to support an overall lower level of volatility, with an estimate on a five-year monthly basis starting at Yahoo! Finance of 1.01x (i.e. virtually no deviation from broader markets). On the other hand, ETF.com provides “up beta” and “down beta” estimates of 0.85x and 0.97x, respectively. Although these are “low volume” readings, the lower beta (relative to the lower) would suggest an unfavorable balance. Yet, we already know that IEMG has underperformed SPY (for example) over the long term (to date); and a quick check of the chart would allow us to see that IEMG did not fall more drastically than SPY during periods like the March 2020 stock market crash.
As always, there is a trade-off between risk and return. Modest levels of “beta” are welcome, but the chances of “alpha” or outperformance will likely be more limited as a result.
IEMG Portfolio Key Data
Due to the availability of a recent benchmark fact sheet for IEMG, one can refer to the MSCI Emerging Markets IMI for some key data. Important points include price/earnings, price/pound and return on equity. IEMG’s benchmark, as of December 31, 2021, had a price-to-earnings ratio of 14.41x, a forward price-to-earnings ratio of 12.41x and a price-to-book ratio of 1.84x.
Therefore, the return on future earnings was 8.1% and the forecast return on equity (dividing future earnings by the current book value) was 14.83%. These are pretty solid numbers, especially forward earnings yield relative to the current risk premium for mature market equities (4.90%; see next section), but we have to consider idiosyncratic risks (in in this case, country-specific risks).
In any case, the return on equity of IEMG’s underlying portfolio is decent at around 15%, suggesting a reasonably high level of business productivity, especially in light of the fund’s higher level of diversification. , and reasonably high exposures to more mature sectors such as financials.
In my last IEMG article, I referenced the morning star data indicating a three- to five-year revenue growth rate of 15.37% per year on average (at the time). The most recent estimate is about the same, at 15.93% (not significant). However, this is done on a higher ‘rolling earnings’ basis, so the consensus estimate of earnings growth prospects in emerging markets would now look a bit stronger than before.
I think the consensus would seem to indicate a belief in a continued recovery and resurgence in emerging markets. However, in a valuation case, I’d err on the side of being conservative, and so I’m going to assume an average earnings growth rate closer to 10-11%, declining to near the weighted risk-free rate of the funds of 4% (I’m stopping at 5% in this case, implying still positive real earnings growth at the end).
Estimated cost of equity for IEMG
IEMG’s country exposures mean that we have to arrive at a cost of equity by weighting each of the country exposures in the portfolio. I also choose to revalue the result upwards to account for other balances/cash.
Use of teacher data Damodaran (for its current estimate of the mature markets equity risk premium of 4.90% and country risk premium data) and Global government bonds (for 10-year local government bond yields, as the “risk-free rate”), I arrive at the calculation below.
For Saudi Arabia and UAE, due to lack of data, I could assume a real interest rate of zero, based on CPI inflation of around 1% for both Saudi and United Arab Emirates over the past 10 years. However, I will assume a 2% spread on the current US 10yr of 1.793%, consistent with my recent analysis on Saudi equities. (I assume that Saudi Arabia and the United Arab Emirates share similar country risks.)
My estimate of the cost of equity is therefore 10.03%, which includes a basis risk premium of 4.90%, a weighted country risk premium of 1.16% and a weighted risk-free rate of 3, 97%
IEMG Short Term Rating Gauge
Using all the above data, I generate the IEMG stock short-term valuation gauge as shown below.
The valuation would suggest a 10% upside, or in other words, IEMG may be pricing in excessive risk to some degree. That is to say, despite strong recent entries.
A simple scenario analysis of our average earnings growth rate to just under 15% would result in a potential upside of around 30%, while disappointing earnings growth rates of around 7% on average (including the year-ahead earnings growth estimate of 16.12%) leads to downside potential of around -5%.
All in all, I think IEMG is probably fairly valued, and that with a cost of equity of around 10%. The risks remain; for example, China is the most exposed country and is likely to continue in a state of economic contraction in the short to medium term. The Bank for International Settlements has also shows that the level of lending (on a GDP scale) to the non-financial private sector by banks (i.e. the “credit impulse”) was negative year-on-year in the second quarter of 2021, which could be a leading indicator of negative earnings growth surprises in the first half of 2022.
However, even earnings disappointments would likely not produce a significant decline, based on a simple scenario analysis. Therefore, I would not take a bearish position on IEMG. I would take a neutral stance though, as the fund’s cost of equity of 10% is not exciting enough given the risks of recession in China.