Schwab Emerging Markets Equity ETF SCHE combines a cost-effective approach with an ultralow fee that should help it perform well against its Morningstar Category peers. But it comes with risks inherent to emerging markets that may not be adequately compensated. The fund earns a Morningstar Analyst Rating of Bronze.

The fund tracks the FTSE Emerging Index. It covers large- and mid-cap stocks from more than 20 developing nations, including locally traded China A-shares. The portfolio excludes Korean stocks because FTSE classifies South Korea as a developed market. This strategy weights holdings by market cap, an approach that benefits investors by capturing the market's collective opinion of each stock's value while mitigating turnover and trading costs. Occasionally it will increase the fund's exposure to expensive stocks when investors get excited about an area of the market, but that doesn't undermine its long-term efficacy. FTSE institutes a buffer around the lower cap bound to further limit unnecessary trading. 

This well-diversified portfolio mitigates the impact of the worst-performing stocks. As of February 2023, it holds more than 1,800 names and its 10 largest positions accounted for only 21% of assets. The index started including locally traded China A-shares mid-2019 and has since added several other countries, further expanding its reach. 

Chinese stocks accounted for nearly 34% of the portfolio as of February 2023. While this is representative of the relative size and importance of the Chinese equity market, it could also expose the fund to concentration risk.

In general, emerging markets face greater geopolitical risks than their developed counterparts. The recent Russia-Ukraine conflict highlights such risk. Shortly after the invasion, FTSE removed Russian stocks from the fund’s target index and the fund marked its Russian allocation down to zero. Russian stocks represented 3% of the fund at the end of January 2022, so the impact on performance was somewhat muted.

The fund charges an 0.11% annual fee, which is among the cheapest in its category. This ultralow price tag has helped it outperform the category average and should continue to provide a durable advantage.

Analyst Rating

Competitive price tag on a well-constructed portfolio.

Analyst

Lan Anh Tran

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This portfolio captures the composition of the emerging-markets equity universe. However, it is more concentrated in the largest emerging markets while possessing a level of political risk absent from developed economies. It earns an Average Process Pillar rating.

Average

Process

Schwab has strengthened its equity index management team over the past few years under the leadership of Chris Bliss. It earns an Above Average People Pillar rating.
Bliss leads Schwab's equity index team. Since joining Schwab from BlackRock in 2016, Bliss has strengthened the team by increasing specialization and automating more of the managers' workflow. This allows the managers to spend less time on routine tasks and helps them better identify and resolve issues that require their attention. Chuck Craig and David Rios join Bliss as named managers on this fund. Jane Qin was previously named as manager on the fund, but she left to oversee portfolios in Schwab’s personalized indexing effort in June 2022. 

The named managers have support from associate managers who help the team prepare for index rebalances. The team looks for ways to slightly improve returns by handling some corporate actions differently from the index. The managers can take advantage of those opportunities when they occur, under tight tracking-error constraints.

Schwab compensates its managers based on tracking error and compliance with risk management, which helps align their interests with investors'.

Above Average

People

Schwab Asset Management Solutions continues moving along the path established years ago, focusing on low-cost core investment strategies and solutions. It maintains its Above Average Parent Pillar rating.

Rick Wurster oversees SAMS--Schwab’s asset-management arm, which as of late 2019 houses its legacy investment management, advisory, research, and client solutions businesses under one roof. The division maintains a strong focus on Schwab’s core fund lineup while investing in other areas to reduce costs and grow its investment capabilities. Its recent investments have focused on new technology to improve operational efficiency and risk management, including automated risk reporting. Portfolio management teams have benefited from some of those advances. The index-tracking portfolio management team, which oversees about half of the firm’s assets, consistently delivers tight index tracking that is on par with the best teams in the business.

SAMS supports Schwab’s brokerage business, and its funds are used in many client solutions. That setup, along with a more efficient operation, helps funds grow quickly and allows Schwab to keep management fees in line with its bigger competitors’. Historically, Schwab has quickly responded to fee cuts from its competitors by lowering the expense ratios on its own funds. The firm’s index-tracking mutual funds and exchange-traded funds typically sport some of the lowest expense ratios in their respective categories.

The firm has remained disciplined in its product development. New strategies are few and far between, and recent launches fit well with its low-cost core lineup.

Parent

Schwab Emerging Markets Equity ETF

SCHE tracks an index of emerging markets companies weighted by market cap.

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The Schwab Emerging Markets Equity ETF has attractive valuations and improving fundamentals in emerging markets, but its high exposure to China and its underperformance compared to the S&P 500 makes it a risky investment. Despite a decline in 2022, SCHE has stabilized in 2023, and its valuation is more attractive, with the revised Buffett Indicator showing that the market valuation of the top countries in SCHE's portfolio as either fair or cheap. However, the ETF's high exposure to China, which faces potential long-term economic challenges, and its underperformance compared to the S&P 500 due to the higher risk of emerging markets, make it a less desirable long-term holding for investors.

SCHE: Attractive Valuation But Exposure To China Is Way Too High

SCHE, and emerging markets more broadly, have had a decent start to 2023. I think this is a story that can continue in the months ahead. The base case is that the U.S. and other developed markets may be entering a recessionary period. By contrast, many emerging markets like China are expected to see stronger growth.

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SCHE's portfolio is less risky, due to high level of diversification, low expense ratio, lower volatility, and investing in right sectors in the most promising EMs. SCHE has been paying low but decent yields. Lower risk and potential growth of equities in emerging markets are expected to sustain the current level of yield.

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In an economic downturn, higher-growth EM stocks that have derated and have strong and stable earnings could outperform, in our opinion. In China, we are cautiously positive on possible policy changes ahead and early signs of a roadmap out of zero-COVID.

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Schwab Emerging Markets Equity ETF tracks The Financial Times Stock Exchange 100 Index (FTSE) emerging Index, less fees and expenses. SCHE invests in over 20 emerging markets with its largest stakes in China and India.

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Emerging markets have struggled in 2022, along with most of the market. Looking ahead to the new year, I see more of the same. China has been a headwind, and that could change as the country re-opens. This is a big opportunity in normal times, but I see geo-political risks outweighing some of the potential.

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SCHE, and emerging markets more broadly, have had a difficult time over the past year. While that is true for developed markets as well, EM has underperformed. While there is a valuation gap that could pique investor interest at these levels, I see too many headwinds to really get comfortable with this space.

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SCHE, which tracks an emerging markets index, has come under a lot of pressure over the last few months.

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Emerging markets saw less of a growth drop in 2020 and are leading the developed world, in terms of growth, in 2021 as well. The recent G-7 agreements show a willingness among developed countries to hike corporate taxes. This could leave emerging markets with a distinct competitive advantage.

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News for Schwab Emerging Markets Equity ETF ETF (SCHE)