A number of emerging markets products have been shifting gears recently with outside-of-China strategies. Most fund issuers have launched new ex-China versions of existing products. The Freedom Emerging Markets 100 ETF (FRDM) is one example of such a fund, and I've written about here before. Let's take a look at this fund against some new competition.
The FRDM fund avoids China based not on any particular tactical premise, but rather, on the premise that China and countries like it fail to provide their citizens with civil, political, and economic freedoms. Further, because of the lack of these freedoms, the economies of these types of countries do not represent suitable, long-term investments.
FRDM is in a space occupied up until now by so-called "indie," or independent exchange-traded fund issuers, small, oftentimes, single fund issuers who rely on white label providers to get their funds launched. Recently, FRDM got some new competition, however, from none other than $220-plus billion issuer First Trust Advisors with their launch of the First Trust Bloomberg Democracies ETF (EMDM) . Let's take a look at these funds and see how they differ.
Freedom Vs. Democracy
In terms of fees, First Trust continues to implement a premium pricing model and has set the expense ratio for EMDM at 75-basis points (bps) as compared to FRDM's 49 bps. A shareholder with $1,000 invested over a calendar year would pay $7.50 in fees over that period as compared to $4.90 for FRDM. Let's move on to each strategy's methodology.
As mentioned earlier, FRDM considers civil and political freedoms as well but also makes assessments of economic freedoms. Data is sourced from the Cato Institute and the Frasier Institute.
EMDM uses underlying civil and political liberties data to determine which countries meet the minimum standards to qualify as an electoral democracy, according to the Washington D.C.-based Freedom House, a group that conducts research on and advocates for democracy, political freedom and human rights.
"To be classified as an Electoral Democracy, a country must have a score of 7 or better in the Electoral Process subcategory, an overall Political Rights score of 20 or better, and an overall Civil Liberties score of 30 or better according to data from Freedom House," the fund prospectus states.
The index methodology goes on to direct interested readers to the Freedom House website for a more detailed description of the evaluation process. While the methodology doesn't call out economic freedoms explicitly, my take is that the reasoning here is that if a country can be described as an electoral democracy then it follows that the environment for economic mobility, ability to start businesses, and standing in international trade is favorable.
The Portfolios
On the face of it, these two funds seem like they might have more in common than not, given their focus on 10 emerging market countries that reject authoritarianism and a 100 security portfolio. While they do have eight countries in common, they only share 39 names in total. From a country exposure perspective, EMDM provides exposure to India and Peru for its shareholders and FRDM includes Poland and Malaysia. EMDM sets a security market capitalization minimum of $500 million and an average daily liquidity minimum of $2 million. FRDM selects securities from the Solactive GBS Emerging Markets Large & Mid Cap Index, which sets market capitalization thresholds by mandating that the index capture 85% of a country's market capitalization. While this may sound a little fuzzy this approach is standard for developing individual country indexes. Also, it is mostly the case that emerging markets are dominated by a small group of large and liquid names, so there aren't going to be any so-called "long tails" of very small names.
Another difference between the two funds is FRDM states it avoids owning State-Owned Enterprises (SOEs), while neither the prospectus of methodology guide for EMDM had explicit language on SOEs, at least not any I could find.
Wrap It Up
Since FRDM's launch in 2019, the fund has gathered just under $370 million in assets under management which, for what is essentially a single pair of boots on the ground during a global pandemic, is an astounding feat. I have no doubt that First Trust will be able to readily raise assets in EMDM. The question comes down to investors' understanding of the EMDM and FRDM approaches and how they may fit into an overall allocation. First Trust's investor guide for EMDM makes the broad case for emerging markets in the near-to-mid-term, so that bodes well for both strategies. Which one ends up in your portfolio comes down to understanding what each fund is doing. As they old saying goes, knowing is half the battle.
