# What is the best way to add an emerging markets allocation to my portfolio?



## cjk2 (Sep 19, 2012)

I currently have no exposure to emerging markets. Basically, when I started investing a few years ago I was a complete newbie and decided to get my feet wet by starting with the TD e-series since they were the easiest (ETFs were scary to me back then). Unfortunately, TD does not have any emerging markets e-series funds so I only held TDB911 for my international equities (developed markets only). Since then, I have moved into a half e-series, half ETF setup. In the next few months I am planning to eliminate my e-series completely and go 100% ETFs. However, I never really thought about adding emerging markets to my portfolio until now (an oversight on my part).

Anyways, I am planning to split my current international holdings into 75% developed, 25% emerging markets. The question is, how should I do this?

1) Make the switch immediately by selling off 25% of my current international equities, and buy emerging markets. (Note: I will not incur any taxes from this because the switch will be made only in my registered accounts.)

2) Don't touch my current holdings, but going forward, buy emerging markets only. Once this has reached 25% of my international holdings, buy a 25/75 split of emerging/developed going foward. (Unfortunately, because I have waited so long to make the switch, I estimate it will take nearly 15 months for the emerging markets portion to "catch up" using my new contributions only.)

3) "DCA" from developing -> emerging markets, e.g. let's say every 2 weeks I convert $2700 of developing -> emerging. (I'm using $2700 because I want to avoid paying commissions with this switch, and with National Bank there is no commission if you buy/sell at least 100 units of an ETF; right now, 100 units of XEF = approx. $2700.) It would only take a few weeks/months to complete this conversion.

Which option is better? Also, any comments on whether XEC vs VEE would be better? (I'm leaning towards XEC because I hold XEF, and I think if I switch to VEE I will be missing out on South Korea?) Finally, is 75/25 a good ratio to pick?

I don't really pay attention to the markets, so if anyone can comment on how the international equities are doing right now that might help me decide. (E.g. if developing markets are overvalued while emerging markets are undervalued, I will be more inclined to go with option 1. On the other hand, if the opposite is true I will be more inclined to go with option 2.)

Thanks everyone!


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## mordko (Jan 23, 2016)

A few suggestions:

1. 25% in EM is quite high. There will be quite a bit of volatility and you will need a lot of intestinal fortitude. Float-adjusted (without government ownership), these markets represent around 15% of the world capitalization. 

2. Yes, XEC is better than VEE, if you use XEF for developed markets. Personally, I use VWO/VEU pairing. VWO is cheap (0.12 MER), but it's in USD. 

3. Whether something is "overvalued" or "undervalued" is a matter of guesstimates of what the future profits will be. Right now it's very hard to predict. What if there is a trade war between the US and China? What if US dollar tanks (as Trump wants it too) - that would help EM economies quite a bit, up to a certain point. EM multiples are not as high as for the US market, but there is a reason for that. 

4. If you believe that 75/25 is the right allocation then there is absolutely no reason to wait.


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## GreatLaker (Mar 23, 2014)

I'd go with option 1. For 25% of whatever % international you hold, I would not bother with your option 2 or 3. Just take the simple route. I have the same allocation you are thinking of: international equity split 75% developed (XEF) and 25% emerging (XEC).

XEF/XEC are a good combination, like you said iShares and Vanguard use different indexes so if you hold XEF and VEE you would not have any Korea exposure. Similar if you have VIU/XEC you would have double Korea exposure. VEE is more diversified than XEC, 4200 holdings vs. 1900. CCP did a blog on it suggesting iShares will also add China a-shares to bring it to parity with VEE. 
http://canadiancouchpotato.com/2015/06/24/china-grabs-a-bigger-share-of-the-indexes/

You may find a lot of polarized opinions on emerging markets here... some people hate them. I tend to prefer greater diversification where it can be obtained at reasonable cost. It tends to zig when the US market zags, and be somewhat correlated with Canada, both have a lot of commodity exposure. Check how volatile it is here: http://www.stingyinvestor.com/cgi-bin/PeriodicTableofAnnualReturns.cgi

I like what you are proposing to do, but it's how my portfolio is already set up, so I might have confirmation bias. :soap:


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## Killer Z (Oct 25, 2013)

I think your option 1 make the most sense as it is the most simple. I generally strive for the simple solutions when investing.

I have been using VDU and VEE for my developed and emerging positions. I believe you would be fine with either VEE or XEC. If you look at their 5 year chart, VEE has slightly outpaced XEC by approx. 1.5%, however they have essentially danced in sync this entire period.


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## m3s (Apr 3, 2010)

cjk2 said:


> Anyways, I am planning to split my current international holdings into 75% developed, 25% emerging markets. The question is, how should I do this?
> 
> 1) Make the switch immediately by selling off 25% of my current international equities, and buy emerging markets. (Note: I will not incur any taxes from this because the switch will be made only in my registered accounts.)
> 
> ...


As you mentioned this would be in a registered account, I hold VWO in RRSP for emerging market exposure (USD equivalent of VEE) I understand there are tax advantages to this in an RRSP and it also helps me diversify currency (holding ~50% of my portfolio in USD was nice as CAD went from 1.10 to 0.70 etc) I pair it with VEA in RRSP for international exposure. If someday I wanted to shift this from RRSP to TFSA I may switch to VEE/VDU. I use Norbit's Gambit to reduce currency exchange expenses

I think your 3 options are a question of timing. I would look at the situation of each to decide if I feel that it's a good time to switch all at once (just use you crystal ball!) Otherwise if fees and taxes aren't an issue as you say DCA may be the more methodical approach but that also requires some extra effort and time to pull of properly. I would probably go with option 1 to keep it simple as mentioned above



> In an RRSP, using US-listed ETFs for foreign equity holdings can bring a significant tax advantage. That’s because these securities are exempt from the usual 15% withholding tax on dividends imposed by the US government. Assuming a 2% yield on US stocks, the tax savings amounts to 0.30%.
> 
> In taxable accounts, Canadian-listed ETFs are generally a better choice. US-listed ETFs offer little or no tax advantage, and in cases where there would be a small benefit it’s likely to be outweighed by other considerations, including currency conversion costs and additional recordkeeping—more on this below.


source


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## cjk2 (Sep 19, 2012)

Thanks to all for the responses! Option 1 is definitely the simplest but I was a bit worried that I would be making the switch at a bad time (e.g. I might end up "buying high and selling low" if developed markets are undervalued right now and/or emerging markets are overvalued). As you guys have pointed out it is probably difficult to really determine this so I guess I shouldn't worry about it.

I do like VEE better if it's much more diversified, but I guess I will have to stick with XEC to get the Korea exposure for now (perhaps I will switch over to Vanguard funds in the future if it makes sense). At the moment I think I will stick with Canadian ETFs, perhaps I will make the switch to VWO/VEA in the future but at the moment doing a currency conversion to USD seems more hassle than it's worth.

Hmm, with mordko's comment I do wonder if my allocation to emerging is a bit high. I was originally thinking 20% (which is a closer reflection to the actual weighting I think), however I feel like emerging markets have more potential for growth. I realize there will be more volatility but I think I am ok with that...


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## Koogie (Dec 15, 2014)

My allocation directly to EM is zero. I have never found the sector to be anything other than a value trap. And the volatility can be eye watering. I gave up on it during the last millennium ('99 to be specific).

I think about it this way. I use very, very diversified ETFs to hold my US and International allocations (VTI and VXUS). They include every company you have ever heard of and all the global titans. These companies are all in these emerging markets, selling their products and services and extracting value from them. That is enough exposure for me.


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## Bill G (Jan 8, 2017)

Some good comments and advice here.

My 2 cents:

* VEE and XEC both have their main holdings as a US ETF. If I understand the Canadian Couch Potato taxation of ETFs articles, for RRSP accounts, there is "double un-recoverable" withholding taxes on dividends that act as a drag on performance. (i.e., you can't recover the withholding taxes paid by the US ETF, nor the withholding taxes paid by the Cdn ETF). The effect is not extreme - around: ~-.69% (or $69 per year, per $10,000 invested). 

* Canadian ETFs that hold emerging market stocks directly are rare ... ZEM from BMO gets relatively close (i.e., has a few country ETFs, but more direct holdings). This reduces - as I understand it - the withholding taxes payable from the US ETFs to the Canadian ETF.

* HAJ is an active Emerging Markets ETF from Horizons, but is quite small and looks nothing like the index. It has mostly direct holdings.

* I own the XEC/XEF pair in my taxable cash account. I'm not "thrilled" with the XEC weights - 53.8% in China / South Korea / Taiwan. I hold an actively managed EM mutual fund in my RRSP to supplement by EM exposure (currently the RBC Emerging Markets Series D fund).

* I'm intrigued by MEE, which just started trading this week. It's a smart-beta ETF from Mackenzie that purports to construct a portfolio on "maximum diversification" parameters ... to avoid the over-weight of - for example: "Nortel", "Valeant", "financials", "energy" at their market tops - that has been identified as a short-coming with market-capitalization indices. Mackenzie has other "maximum-diversification" ETFs that have been around for a few months (e.g., MXU, developed world ex-North America). I plan on watching how MEE and the other "maximum-diversification" ETFs do as they start to get a track record.


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## latebuyer (Nov 15, 2015)

Thanks for posting the table of returns. I've never been a fan of emerging markets because i thought they were too risky but i have to say by looking at this it doesn't seem they've performed worse then EAFE. Off topic, but what is interesting is up until 2014 the s&p 500 hasn't been number 1.

Has anyone made the argument that holding emerging markets reduces volatility due to increased diversification?


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## latebuyer (Nov 15, 2015)

No one has brought up xaw which holds US, international and emerging, although only 10% emerging. The advantage is the relatively low amount to drip, i calculated 3500 approximately.


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## james4beach (Nov 15, 2012)

I think it's best to get your EM exposure within a broad international fund like XAW or VXC. There's no good reason to go picking and choosing more alphabet soup ETFs.

XAW is 11% emerging markets which is reasonable.



cjk2 said:


> However, I never really thought about adding emerging markets to my portfolio until now (an oversight on my part).


You didn't miss out on anything; in fact you benefitted by omitting them. The oldest emerging market ETF is EEM, and its 10 year performance is 1.16% per year. You would have made more money in a high interest savings account.


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## james4beach (Nov 15, 2012)

Bill G said:


> I'm intrigued by MEE, which just started trading this week. It's a smart-beta ETF


I would never go with a brand new ETF. These things need some time to prove themselves. And you're talking about an exotic ETF here, something full of hype (smart beta is all the rage lately).

There's no need for all this complexity. You won't see any significant difference from ultra-optimizing which emerging countries you hold.


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## m3s (Apr 3, 2010)

james4beach said:


> I think it's best to get your EM exposure within a broad international fund like XAW or VXC. There's no good reason to go picking and choosing more alphabet soup ETFs.
> 
> XAW is 11% emerging markets which is reasonable.


Just glimpsed at VXC and as expected I already hold half of its top 10 directly.. so yes there is a reason to choose other ETFs imho..

I use ETFs to pad my exposure to things outsides of NYSE and TSE.. besides a few ADRs I don't really want to hold many internationals directly 

For EM I allocate 5% to VWO. I spend time in emerging markets and long term I believe they will rise up.. as the US has begun to self implode

All superpowers do in time, and I'm still relatively young. Until then yes the US multinationals take the EMs lunch


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## GreatLaker (Mar 23, 2014)

For clarification when I said my "international equity split 75% developed (XEF) and 25% emerging (XEC)" I meant emerging is 25% of my total international (ex-North America) equities, not my total portfolio. Overall emerging is 5% of my total portfolio.

Here's a Cdn Couch Potato blog and white paper on withholding taxes. At the bottom of p.13 it indicates the tax drag on XEC is 0.35% higher than IEMG (US domiciled iShares emerging markets fund) in a RRSP, and the same as IEMG in taxable and TFSA accounts. Plus that 0.35% only applies to the % of your portfolio that is emerging markets. So for me the extra tax drag is 0.018%.
http://canadiancouchpotato.com/2016/07/11/foreign-withholding-taxes-revisited/
https://www.pwlcapital.com/pwl/medi...gn_Withholding_Taxes_Hyperlinked.pdf?ext=.pdf

VEE has a lot more holdings than XEC, as I mentioned, 4200 vs. 1900. But looking at the holdings of VEE, by the time you reach the 2000th holding, it is about 0.004% of the total. So those extra holdings are all really small. Plus iShares has indicated it plans on adding China A-shares adding similar diversification.


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## mordko (Jan 23, 2016)

> it's best to get your EM exposure within a broad international fund like XAW or VXC. There's no good reason to go picking and choosing more alphabet soup ETFs.


There could be several good reasons to unbundle XAW. One of these reasons is cost/taxation.


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## GreatLaker (Mar 23, 2014)

And the OP already indicated he or she has XEF for global developed market investments, so XEC is a natural fit.

BMO ZEM is also a compatible choice since it also uses MSCI indexes, although XEC uses MSCI Emerging Markets IMI index which has about 1900 holdings, whereas ZEM is less diversified, using the MSCI Emerging Markets index which has about 450 holdings. The BMO fund holds more of its stocks directly so should have lower withholding taxes, but on the other hand its MER is slightly higher.

Really, these changes are so subtle we can only speculate on which one will perform better. The important thing is pick a portfolio that is balanced and that you believe in and will hold long term. EM in particular is volatile so need to understand that and not get frustrated and sell if it has a couple of bad years.


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## cjk2 (Sep 19, 2012)

james4beach said:


> You didn't miss out on anything; in fact you benefitted by omitting them. The oldest emerging market ETF is EEM, and its 10 year performance is 1.16% per year. You would have made more money in a high interest savings account.


Good to know, that's a bit reassuring! XD

Anyways, I briefly looked into XAW and considered buying it for my non-Canadian holdings going forward, however it will be too much of a mess to try to convert my current portfolio to this setup. I have a mix a of TD e-series and ETFs of Canadian, U.S., and international indexes spread out between RRSP (Canadian & US), TFSA, and non-registered. I don't want to sell anything in my non-registered account as I would incur significant capital gains. And if I held XAW as well as a mix of XEF/XEC/VUN, it would be a big headache tracking my asset allocation. So I've decided to stick to my current setup of purchasing all the ETFs individually for now.

Also, I believe emerging markets being 11% of XAW would actually be pretty similar to holding a 25/75 mix of XEC/XEF (since XAW also includes U.S. which I hold separately).


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## mikeyrofl (Jul 12, 2016)

Just wanted to clarify what's the final call on the best way to get emerging market exposure? Since both VEE XEC are holding US ETFs hence double unrecoveredable withholding tax?


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## Jimmy (May 19, 2017)

I would really look at the balancing of some of these EM ETFs which are risky to begin w. ZEM for example is 28% in IT and 25 % financials. The heavy weighting in cyclical IT stocks is a risk.

I like the low volatility BMO fund series for their more well balanced weightings. For ZLE the MER is a little higher at .53% but they hold all 85 stocks so w holding taxes will be lower. The weightings are more balanced ~ 15% each on avg and the less volatile sectors, consumer defensive, utilities, telcos etc, are more strongly represented. 

https://www.bmo.com/gam/ca/advisor/...sh!holdings#fundUrl=/fundProfile/ZLE#holdings


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