U.S. mega-cap dominance followed by extreme valuations is leading a migration toward international assets, especially emerging markets (EM). In Research Affiliates’ mid-year recap, Chief Investment Officer Jim Mesterzo highlighted a notable divergence across global markets. While traditional U.S. market-cap benchmarks like the S&P 500 remain historically expensive with Shiller CAPE ratios above 40, emerging market (EM) assets present a compelling opportunity.
While there are funds that offer various levels of EM exposure through a market-cap-weighted strategy, a nuanced approach in this niche market is a must. As Research Affiliates noted, broad EM benchmarks are heavily skewed by regional valuation spikes. This was evident in recent speculative runs in East Asian semiconductor hubs like South Korea, while other EM regions remain deeply discounted relative to their underlying fundamentals. For investors seeking broad, disciplined exposure to these opportunities in developing economies without overpaying for localized bubbles, the Schwab Fundamental Emerging Markets Equity ETF (FNDE ) provides a systematic, value-focused option.
Key Takeaways:
- In their mid-year recap, Research Affiliates noted a stark valuation divergence: High U.S. Shiller CAPE ratios favor a strategic pivot toward discounted emerging market assets.
- FNDE mitigates localized bubble risks by weighting companies based on real-world economic metrics — such as sales, cash flow, and shareholder yield — rather than market capitalization.
- Unlike cap-weighted alternatives, FNDE entirely avoids South Korean market volatility due to its underlying index’s developed market classification, delivering pure value exposure to underpriced developing economies.
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Navigating the Emerging Market Valuation Divide
A key takeaway from the mid-year recap is that EM cannot be treated as a single, homogenous asset class. While certain regional indexes have seen valuations swell due to narrow momentum trades, fundamental economic metrics in countries like Brazil show low CAPE ratios, solid real yields, robust commodity production, and favorable macroeconomic backdrops. Furthermore, inflation across many emerging economies has stabilized, offering higher real returns than many developed bond and equity markets.
Traditional cap-weighted EM strategies often fail to exploit these valuation discrepancies. In a cap-weighted index, as a country or sector experiences a rapid price run-up, its weighting in the index automatically increases. In effect, this forces cap-weighted index investors to buy more of what has become expensive relative to their underlying fundamentals. Conversely, undervalued regions with strong operational fundamentals are systematically underweighted. FNDE solves this dilemma by tracking the RAFI Fundamental High Liquidity Emerging Markets Index, which decouples portfolio weighting from stock prices.
The Fundamental Indexing Mechanism of FNDE
With an attractive total expense ratio of 0.39%, FNDE selects and sizes large-cap emerging market companies using audited measures of real-world business scale, or their economic footprint, rather than market capitalization. The underlying methodology assesses specific fundamental metrics:
- Adjusted sales: Measuring a firm’s total share of real economic output.
- Operating cash flow: Assessing actual liquid cash generated from corporate operations.
- Dividends plus buybacks: Factoring in capital returned to shareholders via dividends and net share buybacks.
Additionally, by tying portfolio weights to these fundamental building blocks, FNDE introduces a disciplined, rules-based rebalancing process. When market sentiment pushes stock prices far ahead of their economic footprint, FNDE’s systematic process trims those overextended holdings when the fund rebalances on a rolling quarter basis. Conversely, when fundamentally sound companies in regions like Latin America or EMEA experience temporary price drops, FNDE systematically increases their portfolio weight.
Bypassing South Korean Volatility
When comparing FNDE to a fund like the iShares MSCI Emerging Markets ETF (EEM ), differences become apparent. EEM tracks the market-cap-weighted MSCI Emerging Markets Index, which classifies South Korea as an emerging market. As a result, EEM holds significant exposure to volatile Korean tech giants like Samsung Electronics and SK Hynix, which have seen rampant retail speculation amid the AI buildout.
Conversely, FNDE has no exposure to South Korea because its underlying index universe, the RAFI Global Equity Investable Universe (GEIU), classifies South Korea as a developed market. FNDE’s fundamental methodology weights stocks by economic footprint rather than price, which gives it a distinct value tilt and reduced exposure to high-multiple tech stocks compared to market-cap alternatives like EEM. As mentioned, the avoidance of South Korea results in reduced volatility.
Implementing FNDE in a Portfolio
As Research Affiliates highlighted in their mid-year outlook, elevated U.S. valuations and shifting global rate dynamics favor asset class diversification. FNDE can serve as a core foundation or complement within a diversified global equity sleeve. The fund provides systematic value exposure while filtering out speculative drag that can come with traditional cap-weighted indexes.
By combining a low-cost strategy with fundamental risk management, FNDE enables investors to capture long-term EM expansion grounded in real economic output.
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VettaFi LLC (“VettaFi”) is the index provider for FNDE, for which it receives an index licensing fee. However, FNDE is not issued, sponsored, endorsed, or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of FNDE.
