ETF Spotlight: Seeking growth beyond the US market

Welcome to ETF Spotlight.

This is a series that takes a closer look at ETFs to translate complexity into practical insights for investors. This month I turned my attention to emerging markets.

After a decade of disappointment, emerging market equities finally delivered in 2025, rallying more than 30% and comfortably outpacing the US market’s 17% gain. This marked a meaningful reversal after years of lagging developed market peers.

Whilst narratives born from a single year aren’t entirely reliable, it has sparked fresh curiosity among investors wondering whether the next leg of global growth might come from outside the US.

With that in mind,I’ll be taking a look at the largest emerging market equity ETF on the ASX, Vanguard’s FTSE Emerging Markets Shares ETF VGE and seeing how it measures up.

Vanguard FTSE Emerging Markets Shares ETF VGE

• Morningstar category: Australia Fund Equity Emerging Markets
• Morningstar category index: MSCI Emerging Markets Index

Methodology and composition

The fund tracks the FTSE Emerging Markets All Cap China A Inclusion Index which includes large, mid and small cap stocks from more than 20 emerging economies.

It employs a market cap weighted approach which reflects the market’s collective opinion of each stock’s value. It sorts the broader cohort and holds those that rank in the top 98% by market cap. The strategy uses buffer rules around the cutoff point to help mitigate excessive turnover and additionally employs liquidity screens that make the final index easier to track.

The portfolio’s market cap weighting means it emphasises the larger stocks and tilts heavily toward Chinese stocks vs the category average. We think this delivers exposure to an important pillar of emerging economies, but it limits geographic diversification.

With around 5000 names in its constituency, there is limited concentration risk and the fund’s top 10 positions often account for around 20-25% of its assets.

A notable quirk of this strategy is that it excludes South Korea from the portfolio, reflecting differences in how index providers classify emerging markets. This contrasts with the average fund in the Diversified Emerging Markets Morningstar Category, which allocates roughly 10% to South Korea.

Our research analysts believe the portfolio captures the composition of the emerging markets universe however it concentrates in the largest markets and its indexing method may not be the best approach to manage risks inherent in these economies.

Is this the best strategy for emerging markets?

The case for emerging markets appears compelling, but the key challenge for investors is trying to capture this effectively. A fund like VGE offers broad, low‑cost exposure to emerging markets, but it also comes with limitations. Market cap weighted funds may struggle to deliver benchmark‑like returns because of the sheer number of holdings and the relative illiquidity of many constituents.

Index rules can lead to the inclusion of companies that may be undesirable from an investment standpoint. This includes the large state‑owned behemoths that are prevalent in several emerging economies. These companies often have objectives that may not always prioritise the interests of public shareholders, which can dilute the benefits of economic growth investors may be seeking.

Investors have previously struggled to fully participate in emerging market upside due to issues such as political instability, weaker corporate governance and limited transparency. An example is the 2022 removal of Russian equities from the FTSE index, which forced VGE ETF to write its Russia exposure down to zero, creating a meaningful drag on returns.

More broadly, there’s also an argument that this approach hasn’t been conducive to strong returns when compared to the category average.

Growth of $10,000 investment at inception. Source: Morningstar. Data as of March 20, 2026.

A market considered more illiquid and inefficient should theoretically give active managers a higher success rate.

Our Active/Passive Barometer report measures the performance of active funds against passive ones in different categories. Latest data indicates that average annualised returns for passive funds are higher in the three and five-year period, which we largely attribute to a passive strategy outlier, the multifactor approach.

I’ve discussed factor investing in a previous article, but in short, the multifactor approach outperformed both the category index and average by a far margin. So, whilst passive as a group appears better, it’s driven by this standout strategy.

The diversification piece

Modern Portfolio Theory states that the more a portfolio is composed of securities with different properties (e.g. sectors or style biases), the lower the degree of risk. So international exposure is one of the first steps towards a diversified portfolio.

From this perspective, most developed international equities have been closely tied to the US. Meanwhile, emerging market equities have historically shown lower correlation. This means they could enhance portfolio resilience, particularly for investors looking to diversify away from US market concentration.

So, does VGE hold up to this? I used Morningstar’s Portfolio X-Ray tool to determine how correlated VGE and iShares’ S&P 500 ETF IVV are. The correlation matrix highlights the historical performance of all holdings over a 3-year period relative to each other.

Source: Morningstar Correlation Matrix Tool.

The results show a positive correlation of 0.70 between VGE and IVV. In practical terms, this means the two funds tend to move in the same direction more often than not, though perhaps not as tightly as developed market peers.

For context, the Australian share market (VAS ETF as a proxy) has a lower correlation with IVV at 0.32, while developed European equities (IEU ETF as a proxy) sit at 0.53. This suggests that VGE might offer some diversification, but perhaps not as much as investors might expect from an asset class that is often viewed as a counterweight to US dominance.

What about the performance hype?

Diversification is only part of the appeal. Many investors look to emerging markets for higher long‑term growth potential as the US becomes increasingly concentrated and top heavy. The question is whether that growth has translated into better risk‑adjusted returns (as measured by the Sharpe ratio*).

A ‘good’ Sharpe ratio is generally considered to be 1.0 or higher, as it indicates the investment provides sufficient returns for the risk taken. VGE delivered a Sharpe ratio of 0.36 which is lower than the category (0.45) and index (0.50). Past performance isn’t indicative of future results, but the gap highlights how challenging it has been for broad emerging market strategies to convert economic growth into investor returns.

Zooming in on the Equity Emerging Markets category and the MSCI Emerging Markets Index, VGE also trails both on a risk‑adjusted basis. If we compare VanEck’s MSCI Multifactor Emerging Markets ETF EMKT, we find that it delivered a five-year Sharpe ratio of 1.08 which represents superior risk-adjusted returns. This perhaps speaks to the benefits of a more selective methodology.

VGE and EMKT 5-Year Risk/Return Analysis. Source: Morningstar. Data as of Feb 28, 2026.

Risk profile

We can’t talk performance without a discussion about risk. Investing is ultimately an exercise of balancing risk and reward. A goals-based investing approach requires understanding whether an ETF’s inherent risk aligns with the outcomes you’re targeting. During the portfolio construction process, your risk tolerance should provide a framework for how much quantitative investment risk sits within your boundaries.

Standard deviation is often used as a measure for volatility. It calculates how widely returns have varied around their historical average. A higher standard deviation means the historic range of performance is wide and therefore the investment is expected to have greater volatility in the future. For many investors, the amount of volatility they can stomach is the practical definition of risk tolerance.

So how much risk tolerance do you need to own VGE?

The strategy has exhibited a 5-year standard deviation of 10.32% which was notably lower than both the category average and index. This is likely due to its extremely broad exposure of nearly 5000 holdings which tends to dampen stock-specific risk. Importantly, this level of volatility is not unusual for global equities, and long‑term growth investors should expect and be prepared for swings of this magnitude.

But investors don’t accept volatility without a reward. Experiencing sharp swings in an investment can be uncomfortable and may trigger poor decisions such as panic selling. Although, if you have a longer time horizon, volatility isn’t something you should necessarily worry about. The more meaningful question isn’t simply how volatile an investment is, but whether that volatility is working to achieve your goals.

As discussed above, VGE’s risk-adjusted returns fell behind both the category and the index. Although VGE has exhibited a slightly lower volatility, its returns have been disproportionately lower. In other words, investors haven’t been rewarded with proportionate returns.

We can also look at a fund’s target market determination to get a better idea of the attributes a potential investor needs to have to own the fund. Vanguard states the product is likely to be appropriate for consumers:

• seeking long term capital growth and some income via exposure to a diversified portfolio of emerging market securities
• who have a high or very high risk/return profile
• who intend to use the product as a core component (up to 50%), minor (up to 25%) or satellite allocation (up to 10%) within a portfolio
• who have a long investment timeframe (the minimum suggested timeframe for holding investments in the ETF is 7 years)

Medalist Rating

Vanguard’s FTSE Emerging Market Shares ETF VGE earns a Morningstar Medalist Rating of Bronze. This indicates that we believe this fund can deliver positive alpha relative to its category benchmark. Our analysts believe the fund offers faithful representation of the market at a low price tag of 0.48%.

The point of this analysis isn’t to arrive at a ‘good’ or ‘bad’ verdict on the fund. It’s to help investors understand what the fund provides, its strengths and limitations and whether it is the approach that aligns with your investment objectives.

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*Sharpe ratio: This is one of the most widely used measures of risk-adjusted relative performance. It subtracts the safe market return from the expected return of an investment and ultimately divides that by the standard deviation. If you have two hypothetical investments that both return 10% p.a. over the long term, the investment with the higher

Sharpe ratio provides better risk-adjusted returns on the basis of lower standard deviation. In basic terms, you get a smoother ride to the same destination (although this rarely occurs in practice). You can read more about standard deviation and the Sharpe ratio here.