Performance and diversification benefits of foreign-equity ETFs in emerging markets

ABSTRACT

This study provides a comprehensive review of the risk-return characteristics, performance and international diversification benefits of an uncharted fast-growing segment of the global exchange-traded fund (ETF) market by examining 17 foreign-equity ETFs traded in 6 emerging markets. The results indicate that the sample ETFs domiciled in these economies perform poorly providing relatively low returns while exposing emerging market investors to substantial total and systematic risks. In addition, these ETFs are found to be more sensitive to downside risk, making them relatively more vulnerable to market downturns. Although the foreign-equity ETFs are designed to provide investors with full international diversification benefits, we find that they are significantly affected by their local market conditions and sentiments, making them ineffective international diversification tools.

KEYWORDS:

• ETFs
• emerging market
• international diversification
• fund performance

JEL CLASSIFICATION:

• G11
• G12
• G15

Acknowledgement

This work was supported by Mahidol University International College, grant number 021/2013.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The popularity of this specific segment of ETFs can be dated back as far as a decade ago. The trade volumes of some foreign-equity ETFs such as the db x-trackers MSCI Japan, the Goldman Sachs Hang Seng Exchange Traded Scheme and the W.I.S.E. Yuanta/P-shares CSI 300 have increased at an astronomical average annual rate since their inception years.

² See Chena & Huang (2010), Purohit, Choudhary and Tyagi (2014), Purohit and Malhotra (2015), Lin, Chan and Hsu (2006) and Lin and Chiang (2005) for more details.

³ While Phengpis and Swanson (2009, 2011) and Tsai and Swanson (2009) propose that the international diversification benefits obtained from foreign-country ETFs are greater, compared to those derived from CEFs and direct investments, others find that the international diversification benefits offered by foreign-equity ETFs are questionable with the empirical evidence of high comovement between ETF returns and markets where they are traded (Gutierrez, Martinez, and Tse 2009; Lee, Hsu, and Lee 2016; Zhong and Yang 2005), high tracking errors of international ETFs (Blitz and Huij 2012) and relatively lower benefits, compared to CEFs and ETFs tracking domestic indices (Kanuria and McLeod 2015; Pennathur, Delcoure, and Anderson 2002). Most researchersfind that foreign-country ETFs outperform CEFs (Harper, Madura, and Schnusenberg 2006; Huang and Lin 2011; Phengpis and Swanson 2011; Yiannaki 2015).

⁴ While there are 23 emerging economies in the MSCI Emerging Markets Index list as of September 2014, the emerging markets such as China, Brazil or Turkey are excluded from the sample in this research because most of the ETFs traded in these markets track domestic indices or that there are insufficient data for these ETFs.

Additional information

Funding

This work was supported by Mahidol University International College, grant number 021/2013.