Barclays Global Investors Set to Introduce Emerging Markets iShares By John Spence September 23, 2002

San Francisco-based Barclays Global Investors today announced it has filed a prospectus with the SEC for an iShares exchange-traded fund tied to the MSCI Emerging Markets Free index. If approved, it will be the first emerging markets ETF - currently BGI has iShares tied to the broad international MSCI EAFE index, as well as several country-basket funds.

It will be interesting to see how the fund is received by investors. Emerging markets have generally been a volatile and poor-performing asset class over much of the past decade. However, there has been a steady call from index investors for more passive funds tied to broad international benchmarks.

"There is strong demand to bring to market a cost-effective, tax efficient way for investors to gain broad-based exposure in emerging markets," said Lee Kranefuss, CEO of individual investor business at BGI.

The MSCI Emerging Markets Free (EMF) index is a float-weighted benchmark that tracks 26 country indexes from Asia, Latin American, Eastern Europe, and other emerging markets. Emerging markets funds are not for the faint of heart because developing nations carry extra currency, political, economic, and regulatory risks. The asset class is notoriously volatile, and investors stand a chance to win big or suffer painful losses. The chart below shows annual calendar-year returns for the MSCI EMF index against the broad domestic Wilshire 5000 index.

Source: Morningstar data

The MSCI Emerging Markets Free index barely came out in the black in the last decade, with a 10-year annualized return of 0.18%, according to Morningstar. The Wilshire 5000 returned 9.61% annually over the same period, and with less volatility. The 10-year standard deviation (a measure of volatility) for the MSCI EMF was 24.55%, compared to a less bumpy 16.48% for the Wilshire 5000.

Despite their poor performance in the 1990s, many analysts believe emerging markets funds can diversify a portfolio and reduce overall risk because they tend not to move in lockstep with U.S. markets. Also, emerging markets stocks are currently cheap relative to domestic securities. As of the end of August, the MSCI EMF had a price-to-earnings (p/e) ratio of 14.31, compared to 27.1 for the S&P 500.

Vanguard does offer an emerging markets index fund that has been around since 1994, although the fund doesn't track the MSCI EMF index. Rather, its benchmark is the Select Emerging Markets Free index, which is administered exclusively for Vanguard by MSCI. The index consists of stocks that can be bought free of restrictions in 15 emerging markets in Europe, Asia, Africa, and Latin America, adjusted to include a 5% cash component that is based on the Lipper Money Market Average, according to Vanguard.

The Vanguard emerging markets index fund has outperformed the MSCI EMF index with a 5-year annualized return of -5.53% as of the end of August, according to Morningstar. The MSCI EMF returned -9.39% annually over the same period.

In July, Vanguard filed an application with the SEC to introduce exchange-traded fund shares for three of its existing international index funds, including the emerging markets fund.

More iShares activity

MSCI said today it has entered into a non-exclusive agreement with the Chicago Board Options Exchange (CBOE) to trade options on the iShares MSCI EAFE. According to a statement, the CBOE will list options on this ETF starting September 25.