Morningstar Writes Back

I heard back from the author of the Morningstar report on VWO that I wrote about on Thursday. His name is Dan Lefkovitz and he was very cordial.

He answered my questions about his report and I will paraphrase his replies and try to analyze the logic. He said that difference in performance is mainly attributable to EEM having Russian exposure, VWO managers choose not to have Russia in the ETF. OK so no Russia? Anyone else think that not having Russia causes a big style drift and misses a big chunk of the asset class?

I think there may be less to the Russia argument than meets the eye. I counted Russia as having a 4.22% weight the following are the top four; Lukoil 1.79%, Surgutneftgaz 1.28%, Norlisk Nickel 0.38% and Vimplecom 0.32%. I may have missed some in my total but ETFconnect confirmed that EEM has less than 5% in Russia.

This is a chart comparing the four largest Russian components to EEM for the last year. Norlisk at a 0.38% weight is the only one in the top four that beat EEM in that time period. Any alpha added by Norlisk was more than offset by Surgutneftgaz, which lagged the fund by what looks like 25% (again I am eyeballing the chart). Dan’s point about Russia stands up much better when you look at a two year chart. I didn’t paste it in to the article because formatting two pictures into one post is brutal or I just have poor blogging skills. All four names outperformed by a wide margin for two years.

Given what might be coming for oil and other natural resources in the next few years I have to wonder why anyone would prefer emerging market exposure that does not include Russia.

In my email I also questioned if there was any forward looking analysis in his preferring VWO because I don’t think there really was any. He said that Morningstar has done several studies that show expenses are a far better predictor of future returns than past performance. Ahem, none of that sounds like forward looking analysis to me. It also does not address how much emerging market exposure to have in a diversified portfolio or why, looking forward and based on portfolio composition, he thinks EEM is a better choice.

To his point about expenses being a better predictor of future returns I asked him in a second email if they have done those studies on ETFs because that sound like a nugget that would pertain to OEFs more than ETFs. He emailed back that they haven’t looked at ETFs yet in that way but he thinks that low expenses will hold up for ETFs too. Kudos to for him admitting this but this is a big oops for his argument.

He also mentioned the work that Morningstar has done studying expenses on index funds and they say cheaper is better. I’m not sure that holds up universally for ETFs because while there are too many ETFs that are similar there are not too many that are exactly identical.

Lastly I would add another point he made which is that although EEM has outperformed VWO and its OEF counterpart, VEIEX, since its inception, he feels that two years is not enough time to base a judgment. To which I would add if you are looking in the rear view mirror to analyze what emerging market product is right for you.

The point of this article is not to pick on the author but to point out that a lot of ETF content looks at the wrong the thing; my opinion. You can still learn from these articles but drawing conclusions based on them may not be ideal.


  1. Yes most ETF’s have small differences within the same catagories but how significant are those differences and how can you quantify how important those differences are? Yes keeping Russia out of a fund is a major significance but over time will this make a difference for the positive or negative?

    I would agree with Morningstar, with ETFs the cost difference is the largest factor when analysing two very similar ETFs. If someone is going to look at the differences, look at the breakdown of the portfolios and then breakdown the size this difference is in their entire portfolio – I doubt most will find the small differences very significant.

  2. There is no convincing me that 30-50 basis points cost difference is more important than differences in portfolio composition as a means of forward looking analysis.


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