The Wide World Of ETFs

JC Parets
February 22, 2020

From the desk of Tom Bruni @BruniCharting

With over 5,000 ETFs trading globally, there have never been more vehicles out there for a market participant to choose from, each with their own spin on a traditional asset.

Today I want to take a look at two WisdomTree ETFs that put what's becoming an ever-more popular spin on the vanilla Emerging Market and China indexes out there.

Although I'll briefly discuss the goal/methodology of these vehicles, our primary goal is to look at them from a Technician's perspective. What does this ETF's construction mean for the underlying holdings and exposure it's providing, and more importantly, its effect on price action? 

First, let's start with the ETFs, which are the WisdomTree Emerging Markets Ex-State-Owned Enterprises Fund (XSOE) and the WisdomTree China Ex-State-Owned Enterprises Fund (CXSE). They both look to provide exposure to the Emerging Markets and Chinese markets while excluding state-owned enterprises. For their purposes, State-Owned Enterprises are defined as those with more than 20% of their shares owned by government entities.

They put out an interesting piece on the case for constructing indexes like this, discussing the fundamental drivers that may lead to underperformance from State-Owned-Enterprises and some historical performance metrics over the last decade-plus. Check it out here if you've got an interest in that.

Let's look at it from a technical perspective.

Here's the WisdomTree Emerging Markets Ex-State-Owned Enterprises Fund (XSOE) vs. the iShares MSCI Emerging Markets Fund (EEM) since the XSOE's inception in late 2014. Performance ebbs and flows between the two, but since 2017 the XSOE fund has outperformed by a decent margin.

Click on chart to enlarge view.

We think that can be attributed primarily to the sector exposure associated with these two ETFs. If we look at the fact sheets for both funds as of 12/31/2019, we see that the XSOE fund has a higher weighting to Technology/Communication Services and Consumer Discretionary, with less exposure to Financials and Energy.

Sounds similar to the Growth/Value debate we've been having in the US? Tech has been rip-roaring since late 2016, and Financials have struggled, so it's no surprise that a vehicle with more Tech exposure and fewer Financials is outperforming. When this trend eventually reverses, will XSOE give back some of its outperformance? Well, unless there's a drastic change in the make-up of State-Owned Enterprises, then sector exposure is likely to stay similar, and therefore performance will suffer.

A similar story is playing out in the China version of this ETF, CXSE. State-Owned Enterprises underperformed from 2012-2017 but began to take the lead in mid-2017 and continues to hold onto that today.

Looking at the exposure, we see a similar story. Fewer Financials and more Consumer Discretionary and Technology/Communication Services. As a result, if the Technology over Financials trend continues, we can expect this ETF to continue outperforming as well.

Here's a side by side view of each fund relative to its benchmark, both of which are sitting at all-time highs.

The purpose of this post is not to recommend either of these ETFs on the long or short side, but to remind us of a few things:

First, there is no shortage of investment vehicles out there, ETFs, or otherwise. I'm genuinely amazed at Wall Street's ability to come up with products for everything. Got a thesis? There is likely a vehicle to express whatever thesis you're interested in (however smart or silly it may be).

Second, and more importantly, regardless of the name or mission statement of an index or ETF, it's essential to understand what the drivers of its performance are.

As we saw in the examples above, most of the outperformance of these particular vehicles can be attributed to their sector exposures. We can bicker back and forth about the methodology that ultimately got them to this portfolio, but at the end of the day, what matters is the market trends that the portfolio is exposed to. In this case, Technology exposure is a massive tailwind for the fund. Some day it will be a headwind.

As Technicians, that is the type of information we care about when investing in/trading these vehicles. Other factors like liquidity (volume and bid/ask spread), rebalance frequency/methodology, and others are important as well, but if you don't understand what's the core driver of what you own, then none of these other market-related factors matter.

The current portfolio composition is serving these funds well, though it's important to note that if these Emerging Market Governments ever begin to broaden their exposure to newer industry groups, then the composition of their portfolios, and subsequently these ETFs that are based on them, could change significantly. Just something to keep an eye on as it is a risk to this type of strategy.

Thanks for reading and please let us know if you have any questions!

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Allstarcharts Team

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