Vanguard FTSE Emerging Markets ETF: July 2024 update

• Vanguard is a pioneer in index investing and launched its first ETF in 2001

• This ETF offers exposure to a broad range of countries and sectors across emerging markets

• Its low charges should help it track the FTSE Emerging Index closely

How it fits in a portfolio

An ETF is a basket of investments that often includes company shares or bonds. They tend to track the performance of an index such as the FTSE Emerging Index and trade on stock exchanges, like shares. This means their price fluctuates throughout the day.

The Vanguard FTSE Emerging Markets ETF invests in large and medium-sized companies in emerging markets. These markets are higher risk as they're at an earlier stage of development, so this ETF should only be considered for a portfolio with a longer investment outlook that can accept periods of high volatility.

An ETF is one of the simplest ways to invest and can be a low-cost starting point for an investment portfolio aiming to deliver long-term growth. ETFs that track emerging markets could be used to diversify a long-term global investment portfolio, including those focused on other regions such as the UK, US or Europe.

Manager

Vanguard is a pioneer when it comes to passive investing, having created the first retail index fund over 45 years ago. It now runs some of the largest index funds in the world. Given its size, it has a big investment team with the expertise and resources to track indices and markets as closely as possible, while having scale to keep costs down.

Vanguard ETFs are run by a large, global team. They’re spread across three investment hubs around the world – the US, UK and Australia. This team-based approach means there’s no named manager on the ETF. As a collective team, Vanguard has run this ETF for 12 years.

Vanguard also has a trading analytics team, which is responsible for ensuring the ETFs buy and sell investments efficiently and at a competitive cost. This involves analysing data from different brokers and banks. Lower costs should help the ETFs track their benchmarks as tightly as possible.

Process

This ETF aims to track the performance of emerging markets, as measured by the FTSE Emerging Index. It does this by investing in nearly all the underlying companies in the index. At the end of June 2024, the ETF invested in 2,146 companies versus 2,209 in the index. This is known as partial replication and can help the ETF track the index closely without the need to buy all the smaller companies in the index which can be more difficult and costly to trade.

The ETF has a large weighting in China, India and Taiwan which make up 29.6%, 22.4% and 19.3% of the fund respectively. It’s also concentrated in companies from the technology, financials and consumer discretionary sectors.

Reducing costs is a key part of keeping the tracking difference between the ETF and the benchmark to a minimum. In any ETF, factors like taxes, dealing commissions and spreads, and the cost of running the ETF all drag on performance. To help keep these costs down, the team aims to make large investments in companies instead of lots of small transactions.

Vanguard will also lend some of the investments in the ETF to other providers in exchange for a fee, which can be used to offset some of the costs. They will only lend securities to a limited number of high-quality approved dealers. They indemnify the fund against any loss from this process, meaning there should be no negative impact on investors. However, stock lending is a higher risk approach.

As this ETF is listed offshore investors are not usually entitled to compensation from the UK Financial Services Compensation Scheme.

Culture

Vanguard is currently the second largest asset manager in the world and runs around $8.6trn of assets globally as of March 2024. The group aims to put the client at the forefront of everything it does, which drives its focus on quality, low-cost index products.

John Bogle, known as Jack, founded Vanguard in 1975 and it’s owned by investors. This allows Vanguard to redirect its profits back to investors in the form of lower fees, instead of paying dividends to external shareholders. Bogle believed in creating products that simply track the performance of a market rather than taking a shot at picking individual companies which may beat them.

The team running this ETF works closely with other equity research and risk departments across the business. They have daily and weekly meetings to discuss ongoing strategy which could add good support and challenge on how to run the ETF effectively.

ESG Integration

Vanguard is predominantly a passive fund house. While it has offered exclusions-based passive funds for many years, it has lagged peers in offering passive funds that explicitly integrate Environmental, Social and Governance (ESG) criteria by tracking indices that tilt towards companies with positive ESG characteristics, and away from those that don’t.

Vanguard’s Investment Stewardship team carries out most of the firm’s voting and engagement activity. Their stewardship activity is grounded in the firm’s four principles of good governance: board composition and effectiveness, oversight of strategy and risk, executive compensation and shareholder rights. The Stewardship team produces frequent insights on their engagement activity at both a corporate and governmental level.

Vanguard courted controversy in 2022 when it left the Net Zero Asset Managers’ Initiative, a group of asset managers that have committed to achieving net zero carbon emissions by 2050. It claimed its decision would improve clarity for investors and allow it to speak independently. We view this as a disappointing backward step, but we’re encouraged that the company will continue to engage with companies on climate-related issues.

The Vanguard FTSE Emerging Markets ETF tracks an index that does not specifically integrate ESG considerations into its process. The ETF can therefore invest in shares issued by companies in any sector.

Cost

The ETF currently has an ongoing annual fund charge of 0.22%. The annual charge to hold ETFs in the HL ISA or SIPP is 0.45% (capped at £45 p.a. in the ISA and £200 in the SIPP). There are no charges from HL to hold ETFs within the HL Fund and Share Account or HL Junior ISA. Ensuring an ETF has a low charge is an important part of tracking the underlying index closely.

As ETFs trade like shares, both a buy and sell instruction will be subject to the HL share dealing charges.

Performance

The ETF has tracked the FTSE Emerging Index well since it launched in May 2012, returning 100.83%*. As is typical of ETFs, it’s fallen behind the benchmark over the long term because of the costs involved. However, the tools used by the managers have helped to keep performance tight to the index. Remember, past performance isn’t a guide to future returns.

Over the past 12 months, the ETF has done a good job of tracking the index, rising 13.05%. The technology sector contributed the most to the ETF’s performance, whereas consumer staples were the main detractor.

Taiwan’s stock market was one of the best-performing emerging markets over the year, driven by advancements in Artificial Intelligence (AI). This was led by Taiwan Semiconductor Manufacturing, the world’s largest chip manufacturer, which has seen huge growth due to the strong demand for chips essential for the development of AI.

India’s stock market also performed well and it’s now the world’s fourth largest stock market by country, behind only the US, China and Japan. Despite significant global challenges over the year like the ongoing conflict in the Middle East, the prospect of higher interest rates for longer and slow global demand, India has beaten growth expectations and is the world’s fastest growing major economy.

One area which was challenging over the 12 months was China, which was one of the worst-performing major stock markets over this time. China’s economy hasn’t recovered as many had expected after re-opening from its Covid lockdown at the start of 2023. There have been ongoing concerns surrounding its property sector due to rising house prices, a significant fall in demand and rising debts.

Given Vanguard’s size, experience and expertise running ETFs, this ETF should continue to track the index closely in future, though there are no guarantees.