First Trust launches democracy-focused emerging markets ETF

First Trust has unveiled a new ETF in the US that takes a relatively unexplored approach to emerging market equities by investing only in countries considered to be sufficiently democratic.

The First Trust Bloomberg Emerging Market Democracies ETF (EMDM US) has been listed on NYSE Arca with an expense ratio of 0.75%.

Data from the International Monetary Fund show that the majority of global economic growth is expected to occur outside of the US in the next few years, particularly in emerging markets.

According to First Trust, however, some investors may be wary of investing in emerging markets as traditional investment products have tended to be significantly exposed to countries whose governmental policies and living conditions do not reflect democratic views toward individual and collective freedoms.

EMDM aims to fill this gap by targeting only those parts of the emerging markets ecosystem where political rights and civil liberties are highly regarded including countries that have fair balloting procedures, political competition, and respect for the rule of law and civil liberties.

Ryan Issakainen, Senior Vice President and ETF Strategist at First Trust, commented: “Concerns about the rule of law, political rights, and civil liberties have led many investors to avoid allocating to emerging markets. By screening out countries that are not considered Electoral Democracies, we believe this ETF addresses many such concerns, while also providing exposure to the robust long-term growth potential of emerging markets stocks.”

Methodology

The fund is linked to the Bloomberg Emerging Market Democracies Index which is constructed from an initial universe comprising large and mid-cap stocks across developing countries globally.

The index harnesses insights from Freedom House, a non-profit organization conducting international research on democracy, political freedoms, and human rights, to exclude countries that fail to satisfy the requirements to be classified as Electoral Democracies.

Specifically, Freedom House’s analysis considers a country’s performance in terms of electoral processes, political rights, and civil liberties. Failure to meet the required standard in any one of these three dimensions results in that country’s exclusion from the index.

Once the eligible countries are determined, the index selects the 100 largest companies by float-adjusted market capitalization from the screened universe.

Constituents are weighted using a combination of float-adjusted market capitalization and the total score assigned by Freedom House for the issuer’s country. The weight of any single country is capped at 15% to promote diversification.

The index is reconstituted annually and rebalanced on a semi-annual basis.

The composition of the index looks notably different compared to mainstream emerging market benchmarks. Many typically prominent countries including China and Russia are ineligible for inclusion due to concerns over their restrictions on citizens’ freedoms, while the weight of Brazil is also notably reduced.

As of 3 March, the index’s largest country exposures were Mexico (17.4%), South Korea (16.5%), Taiwan (16.0%), South Africa (15.4%), India (13.2%), and Brazil (12.5%). The index’s sector allocation, meanwhile, was dominated by financials (25.0%), information technology (24.7%), and materials (20.1%).

Notable positions included Taiwan Semiconductor Manufacturing (9.0%), Samsung Electronics (8.6%), Sociedad Quimica y Minera de Chile (4.9%), Grupo Mexico (4.2%), Naspers (4.2%), America Movil (4.0%), and Grupo Financiero Banorte (3.5%).

The fund is actually not the first passive emerging markets equity ETF to incorporate political and social freedoms into its investment approach. The Freedom 100 Emerging Markets ETF (FRDM US), launched in May 2019 by Alpha Architect, offers a similar approach. FRDM houses $370 million in assets and has an expense ratio of 0.49%.