FNDE: weak market conditions, but impressive product references (NYSEARCA: FNDE)
In emerging markets, slow growth in advanced economies has put an end to a traditional development path: export-led growth. As a result, emerging markets had to rely on domestic demand again. It’s always hard task, given the temptation to overstimulate. -Raghuram Rajan
Characteristics of ETFs
Investors looking for options in emerging market equities have a plethora of options to choose from; I think the Schwab Fundamental Emerging Markets Large Company Index ETF (NYSEARCA:FNDE), which has been around for almost 9 years now, is one of the most underrated ETF options. Of course, with an expense ratio of 0.39%, investors might be tempted to seek out other cheaper alternatives in this space, but note that since FNDE’s inception in 2013, it has managed to deliver compounding returns relatively better by almost 1000 basis points, compared to the popular – iShares MSCI Emerging Markets ETF (EEM) whose AUM is 6x that of FNDE.
So what could be the cause of this alpha? Well, there are a whole host of reasons, but above all, I find that the way the FNDE chooses its actions has a lot of merit. Unlike most ETFs which select, rank and weight their constituents using an ad hoc market capitalization approach, the FNDE uses certain fundamental measures of company size; I am referring to metrics such as shareholder distributions (including redemptions), adjusted revenue, retained operating cash flow. You can be relatively sure that stocks that score high on some of these metrics are usually those whose business models have some degree of robustness.
While the FNDE on its own appears to be one of the most promising emerging ETF vehicles, I’m not sure one can be excited enough about the underlying conditions within emerging markets in general. As noted in The Lead-Lag Report, GDP forecasts pointing to the next two years imply a drastic turn of events, although advanced economies should fare much better.
I don’t believe this should be a big shock that developed overnight, as things have gradually changed over the last decade or so; as shared recently with my followers, the relative GDP per capita differential between the United States and emerging markets, which was quite high a decade ago, has compressed considerably, and there does not appear to be a lot of advantage now.
One of the main headwinds at the moment is the trajectory of the dollar, which is at its highest in two decades! If you follow the developments on The Lead-Lag Report timeline, you will notice that I recently engaged in an in-depth analysis of the dollar outlook with Brent Johnson on “Lead-Lag Live”.
We also debated the likelihood of a sovereign debt crisis and whether that brought a different narrative to the dollar story; For the uninitiated, note that emerging market debt is about to hit $100 trillion and the growing interest burden is quickly becoming unmanageable. A few years ago, some people canceled the safe haven status of the dollar, but I think it was perhaps too early to take the plunge.
As with most emerging market-themed ETFs, FNDE is also heavily biased towards the China and Taiwan regions, which together make up nearly half of the portfolio; unfortunately, the macro picture there looks very distressed, which could limit the upside potential of the FNDE. The Zero Covid policy in China has totally upended different cogs of the economy and there doesn’t seem to be an end in sight. Reports today suggest that the Beijing area has witnessed even more cases and the Binhai area in Tianjin has been quarantined.
As noted in The Lead-Lag Report, these lingering lockdowns are having a profound impact on the manufacturing landscape in China, which has seen forward-looking PMIs decline for two consecutive months now.
This also spilled over into port congestion and impacted China’s export momentum, which had previously served as a beacon.
Given this weak macro momentum (GDP growth for the year has now been reduced to 4% from previous levels of 4.5%), it is no surprise to find that Chinese equities have recently experienced the largest monthly releases ever recorded. Unless this ferocity of selling diminishes, it would be difficult for a Chinese product like the FNDE to thrive.
As discussed in the previous section of this article, the emerging markets universe is currently experiencing a series of headwinds that could make it difficult to invest your funds. That said, the opportunities to hold fundamentally superior stocks at low valuations don’t happen too often and you may find yourself with regrets years down the line. For an ETF that has outperformed the popular EM in both the long and short term (note that during this tough year-to-date 2022 for EM, FNDE has also outperformed EEM), the valuation and revenue picture looks very compelling
The ETF is currently only trading at a miserly 6.6x futures P/E, while your flagship EEM is trading at a whopping 65% premium at 10.9x!
Also, if you’re worried about further declines, also consider that you can currently pocket a very lucrative return of over 5%, which can help cushion a fall. The last time we saw yields hit such high levels was during the 2020 COVID-19 lows in March. Also note that the returns are more than 2.5 times better than what you get with EEM