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Excellence In Exclusion For This Emerging Market ETF.

Byline: ETF Professor

With some investments, what the strategy excludes is as important as what it includes. That's the case with the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (NYSE:XSOE).

As its name implies, XSOE is an emerging markets exchange traded fund that excludes state-owned enterprises (SOEs) from its lineup, an asset class that's prevalent in traditional developing markets strategies.

The methodology is meaningful. Year to date, XSOE is higher by almost 10.4% while the MSCI Emerging Markets, which is chock full of state-controlled firms, is up just 6%.

Why It's Important

XSOE's year-to-date performance is certainly tempting compared to basic emerging markets ETFs, but there are other reasons to consider the fund.

"The IMF published a paper in June assessing SOEs in Central, Eastern and Southeastern Europe," said WisdomTree in a recent note. "Their conclusion was that SOEs in the region generally 'generate less revenue than their private counterparts, incur heavier costs of production not least on wages, and as a consequence are significantly less profitable.' Political influences often result in SOEs employing too many people that are paid too much."

Although China is home to a slew of SOEs, its economy is large to have ample amounts of non-government companies. As such, the world's second-largest economy represents over 34% of XSOE's weight. South Korea and Taiwan, advanced emerging markets, combine for nearly a quarter of the fund's roster.

Conversely, Brazil and Russia, just two examples of developing markets with lots of SOEs, combine for just over 10% of XSOE's geographic exposure. Lack of SOE exposure can also help investors avoid some of the volatility associated with commodities prices.

A World Bank study "argues SOE underperformance is in part driven by exogenous factors such as lower commodity prices or other sector-specific factors, but conclude there is 'increasing recognition that poor corporate governance of SOEs is at the heart of the matter,'" according to WisdomTree.

What's Next

There are other reasons, such as better operational metrics and lower leverage to consider, non-SOE companies in the emerging world.

"In a May 2018 note, UBS wrote that the return-on-equity (ROE) of emerging markets SOEs was about 11.05%, compared to 13% for non-SOEs," said WisdomTree. "In addition to higher profitability, UBS also found significantly lower leverage and better performance in favor of non-SOEs, going back a decade."

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Date:Sep 11, 2019
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