Emerging-Market Materials ETFs Aren't All Made of the Same Stuff

NEW YORK ( TheStreet) -- After a disappointing 2011 and a poor start in 2012, emerging-market equities started showing signs of improved performance late last year. Now many investors are hoping these stocks will go on a run like they did in the last decade, when they dramatically outperformed domestic equities.

A big part of the emerging-market story lies in the materials sector, as an ascendant middle class demands and consumes more natural resources. Many emerging-market countries have local materials companies that have benefited from this effect in the past and can in the future as well. Not surprisingly, there are exchange-traded funds that offer access to the space.

Although neither fund has much volume, investors wanting narrow access to emerging-market materials could consider the EG Shares Basic Materials ETF ( LGEM) or the iShares MSCI Emerging Markets Materials ETF ( EMMT). There are similarities between the two; the largest holding in both funds is Vale ( VALE), which makes up 9.3% of LGEM and 13.6% of EMMT. Anglo Gold Ashanti ( AU) also features prominently in both funds.

From there, however, there is not much overlap. That's because the two funds have differences at the country level. LGEM is heaviest in South Africa, which accounts for 21% of holdings, followed by China with 17%, Brazil with 16% and Russia with 15%.

Like many EG Shares funds, LGEM is very BRICS-centric. It also has a 9% weighting in India. EMMT allocates 19% to Brazil, 13% to South Africa, 12% to Mexico and, a little further down the list, 8% to South Korea, which is a result of the 8% weighting in POSCO ( PKX).

Consistent with the BRICS focus, LGEM only covers nine countries, while EMMT covers 15. LGEM also has far fewer individual holdings than EMMT: 30 vs. 63.

Other nuts and bolts: LGEM has a 0.85% expense ratio compared to 0.69% for EMMT. The funds have trailing yields of 4.06% and 2.61%, respectively, but it is always worth mentioning that the dividends paid by ETFs can fluctuate from year to year.

For the trailing 12 months, EMMT has dramatically outperformed LGEM, 10.09% to 3.08%. Much of the difference is because of LGEM's greater exposure to South Africa. During the summer of 2012 there were countless news stories of mine strikes in South Africa and violence between police and striking miners. This weighed very heavily on South African miners like Anglo Gold Ashanti, which is a much larger holding in EMMT and is down 33% in the last year.

This illustrates the need to look under the hood and understand the constituent differences between seemingly similar funds. If Chinese markets have a resurgence in 2013 as some are predicting, then it stands to reason that LGEM will be the one to outperform going forward.

The issues of low volume and low assets in each fund are worth mentioning. Low volume does not mean poor liquidity. If market makers are able to provide executions, then the liquidity is adequate. Anyone interested in either fund needs to be patient and use limit orders.

Low assets always raise the possibility of a fund closure. Predicting whether a fund will close or not isn't as important as making sure you sell out of a fund that announces it is closing. There can be expenses in closing the fund, and anyone holding the fund through the closure would be on the hook for sharing in the expense.

At the time of publication, VALE was a client holding.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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