Is this the best emerging market ETF on the ASX?

I recently explored the renewed investor interest in the emerging market space and how investors can gain exposure.

One fund that stuck out to me for its consistent outperformance and tailored strategy was VanEck’s MSCI Multifactor Emerging Markets Equity ETF EMKT, which I’ll be exploring in this article. But first let’s take it back to basics.

Why do people invest in emerging markets?

There are a few reasons why investors may gravitate towards emerging markets – most of which I discuss in last week’s article should you invest in emerging markets.

More recently, after a prolonged period of underperformance, interest has been reignited given concerns about a weakened US dollar which has historically been favourable for emerging markets. Further to that, tariff-induced economic uncertainty, the narrative of a decline in US exceptionalism and relatively compelling valuations bring fresh eyes to the asset class.

Figure 1: The relationship between the US dollar and emerging markets equities. VanEck. 2025.

Active or passive?

Emerging market equities are generally considered a more illiquid, inefficient part of the market given limited information and analyst coverage. Theoretically this should mean that active managers have a higher success rate in this space.

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.

Figure 2: Morningstar Active Passive Barometer. 2024.

I’ve discussed factor investing in an article for my Young & Invested column. In short, research indicates that a small set of dominant predictive signals or ‘factors’ historically drove asset returns. These include momentum, volatility, liquidity variables (size) and valuation ratios (quality).

Each factor was proven to provide better risk adjusted returns over time, however research concluded that no single one consistently outperformed across all market conditions. Thus, the birth of the multifactor fund strategy, combining the low-cost nature of passive funds, with an added active factor approach to an index.

Why factor invest in emerging markets?

Given the varied success rates of active funds in this category, those who do not wish to take a chance may gravitate towards low-cost, passive ETFs for their emerging market exposure. However, broad market emerging market ETFs are widely considered to be inefficient for a few reasons. I’ve explored this in depth in a previous article below is a short overview.

Broad market emerging market ETFs are often less capable of delivering benchmark returns than developed counterparts, partially due to the number and relative illiquidity of holdings. For example, iShares MSCI Emerging Markets ETF IEM which tracks the MSCI Emerging Markets Index has consistently lagged the benchmark by ~1% over the long term, creating a tracking error* issue.

But tracking error isn’t just a fund metric, it can also be a behavioural signal. Our latest Mind the Gap study found that investors in funds with higher tracking error lagged fund returns by 1.6% per year as opposed to those with lower tracking error lagging <1% annually. A higher tracking error generally results in more volatile returns relative to the benchmark which amplifies poor timing decisions.

Secondly, index rules result in the inclusion of many companies that may be considered undesirable from an investment standpoint. Not all index providers apply quality screening, meaning that those of poor quality are often included on the basis of their market capitalisation.

Opting for a tailored multi-factor strategy that takes an ‘active’ approach to selecting companies can theoretically negate some of these issues.

VanEck MSCI Multifactor Emerging Markets Equity ETF EMKT

Methodology and composition

Launched in 2018, EMKT tracks the MSCI Emerging Markets Multi-Factor Select Index which applies a factor approach to its parent, the MSCI Emerging Markets Index. The parent benchmark includes large and mid-cap stocks, covering ~85% of market capitalisation across 24 emerging market countries. The resulting index has around 1,200 constituents.

The strategy is designed to maximise exposure to holdings within the MSCI Emerging Markets Index that demonstrate enhanced performance characteristics across four style factors: value, momentum, quality, and size.

The tailored benchmark aims to achieve outperformance over the medium and long term, while maintaining a market risk profile similar to that of the underlying parent index. Additionally, exposure to other factors present in the parent index (e.g. volatility) is restricted.

The four target factors were selected based on a historical view of their optimal combined performance – in this case, having delivered the highest information ratio** and Sharpe ratio***.

Below is a summary of the fund’s factor criteria:

• Value: Companies are rated on two equally weighted measures of value: the forward price relative to expected future earnings, and the price relative to the company’s book value.
• Momentum: Companies are given a higher score if their share price has outperformed the market in the last 2 years and has increased over the last 6 months and last 12 months.
• Size: Companies that have a lower market capitalisation relative to others.
• Quality:Companies are scored on five equally weighted measures of value: high return on equity, low debt to equity, low year on year earnings variability, earnings quality and investment quality.

The multifactor approach results in a portfolio of around 200 holdings diversified across over 20 countries. The strategy invests almost 29% of assets in its top 10 holdings, similar to the category average. Notably, over 50% of the ETF’s country exposure is in China and Taiwan, with Taiwan Semiconductor Manufacturing Company taking top spot at 8%.

Figure 3: EMKT ETF composition. Morningstar. Data as of 29 August 2025.

Performance

The strategy aims to help investors achieve active-like returns in emerging market equities for passive fees. One of the predominant contributors to EMKT’s Bronze Morningstar Medalist Rating is its impressive long-term risk-adjusted performance.

Its five-year alpha relative to the category index can be seen in Figure 4 below. Often higher returns are associated with more risk; however, this strategy stayed in line with the benchmark’s standard deviation and produced a higher five-year Sharpe ratio (1 vs 0.51 for category average).

Figure 4: Growth of $10,000 in EMKT since inception vs index and category. Morningstar. Data as of 1 September 2025.

Whilst not displayed in the figure below, EMKT’s long-term absolute returns surpassed the category index over the past seven-year period, outperforming by an annualised 2.6%. It has also come out ahead of peers by an annualised 3.4%, over the same seven-year period.

Figure 5: EMKT ETF trailing returns. Source: Morningstar. Month end as of 31 August 2025.

Risk

EMKT’s consistent outperformance of the benchmark over the long term may be attributed to its use of cyclical factor exposure (momentum, size and value) in rising markets, and a tilt to the quality factor during downturns.

Over a five-year period, the fund demonstrated strong risk-adjusted performance as demonstrated by an upside ratio of 99 (vs 91 for its category), meaning it captured nearly all of its benchmark gains during periods of positive returns. More notably, its impressive downside capture ratio of just 61, compared to 87 for the category, highlights its resilience in declining markets, losing significantly less than the benchmark.

Whilst our Morningstar analysis doesn’t isolate the fund’s factor-level contribution, a 2023 VanEck paper provides detailed capture ratios for individual factors at the time. This offers insight into how each may have contributed to the overarching picture of long term outperformance.

Figure 6: Capture ratios by factor. VanEck. 2024.

What we think

Applying our equity research share level valuations to the underlying holdings shows that EMKT screens 0.95 price/fair value (August 2025), indicating the ETF trades slightly below fair value.

It’s important to note that the 0.69% total cost ratio, whilst seemingly higher than broad-based passive ETFs, is still within the cheapest quintile of its Morningstar category.

We ascribe a Morningstar Medalist Rating of Bronze indicating that we believe this share class can deliver positive alpha relative to its category benchmark.

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*Tracking error is a measure of volatility that shows how closely a fund follows its benchmark index. It’s calculated by the standard deviation of the difference between fund returns and the index’s returns over time. A low tracking error means the fund is closely mimicking the index and a higher tracking error indicates it may be veering off course.

**Information ratio (IR) is a risk-adjusted performance measure. It refers to the ratio of portfolio returns in excess of the returns of a benchmark (usually an index) to the volatility of those returns. This measures a portfolio manager’s ability to generate excess returns relative to a benchmark but also attempts to identify the consistency of the portfolio manager. This ratio will identify if a manager has beaten the benchmark by a lot in a few months or a little every month. The higher the IR, the more consistent a manager is. The information ratio is a special version of the Sharpe Ratio, in that the benchmark doesn’t have to be the risk-free rate.

***Sharpe ratio: The Sharpe ratio 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.