The Pacer Emerging Markets Cash Cows 100 ETF (NASDAQ:ECOW) is the ETF in the Cash Cows family that covers emerging market equities. With a yield of 6.7% and a focus on emerging market companies that sport high free cash flow yields, the ETF looks attractive and has outperformed some of the other major emerging markets ETFs in recent years. Therefore, let’s take a closer look at ECOW.
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Cash Rules Everything Around Me
We’ve recently covered some of the other Cash Cows, like the popular Pacer US Cash Cows 100 ETF (BATS:COWZ), the Pacer US Small Cap Cash Cows 100 ETF (BATS:CALF), and the Pacer Developed Markets International Cash Cows 100 ETF (BATS:ICOW). All of these ETFs prioritize investing in companies with high free cash flow yields, and ECOW is no different — it just adds a different twist to the strategy by focusing on emerging markets stocks with high free cash flow yields.
Why prioritize high free cash flow yields? Think of it this way — free cash flow is the cash that a company has left over after it pays for its expenses and items like interest, taxes, and long-term investments. This is the cash that can be used to buy back stock, pay dividends to investors, or even make mergers and acquisitions. Positive free cash flow signals a successful company, as it shows that the business is generating more cash than it needs, and this cash can then be used to fuel future growth and create shareholder value.
Free cash flow yield is essentially a way to gauge how cheap or expensive a stock is based on the free cash flow it generates, similar to the manner in which a price-to-earnings (P/E ratio) tells us how cheap or expensive a stock is based on its earnings. Free cash flow yield is calculated by dividing a company’s free cash flow by its market capitalization (you can also use the company’s enterprise value to include cash and debt).
While a lower P/E ratio is theoretically more attractive to investors, a higher free cash flow yield is a sign of a more desirable stock for investors who use this metric. Many renowned investors consider FCF yield a more accurate way to gauge the financial health of a company than the P/E ratio because it is easier to make adjustments and changes to earnings than it is to free cash flow.
ECOW prioritizes these types of companies by starting with the FTSE Emerging Markets Index, which contains 500 companies, and then screening for the top 100 companies with the highest free cash flow. These investments are then weighted by their free cash flow yields (higher yield gets a higher weighting), capping positions at 2% to ensure that the ETF isn’t dominated by a small number of stocks.
By doing this, ECOW weeds out many weaker emerging markets stocks and ends up with 100 holdings that sport an impressive free cash flow yield of over 21%. Additionally, a byproduct of this strategy is that these 100 holdings have an attractive average P/E ratio of under 5. This seems like an effective strategy, as these are the emerging markets companies that are successfully generating surplus cash and can use this money to create value for their shareholders.
Solid Historical Performance
This seems like an effective strategy, so how has it played out in practice over the last few years? Over the past three years, ECOW has provided investors a total annualized return of 8.8% as of the end of the most recent quarter. While this return lags the total return of the S&P 500 and Nasdaq over the same time frame, remember that ECOW’s investment universe is emerging markets stocks, which have lagged U.S. markets in recent times.
Let’s instead compare ECOW to two of the largest and most popular emerging markets ETFs today — the Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO) and the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM). Over the same three-year timeframe, VWO’s total annualized return was 6.7%, while EEM’s total annualized return was 7.1%. As you can see, by using free cash flow yield to screen for high-quality emerging markets stocks, ECOW has been able to outperform its larger peers over the last several years.
While it may not sound like a huge difference, ECOW appears to have a tangible edge here, and these differences in performance add up over time.
You could make the argument that investors should just invest in an S&P 500 ETF instead of any of these emerging markets funds, but I think it’s worth it for investors in the U.S. and other developed markets to get exposure to emerging markets, both to add some diversification away from their home markets and to tap into the higher long-term growth that emerging markets potentially offer.
ECOW’s Holdings
Now that we’ve discussed ECOW’s strategy and its track record versus emerging markets peers, let’s take a look at its individual components. ECOW holds 100 different stocks, and its top 10 positions account for just 23.4% of holdings, so this is a very diversified ETF. In case you are wondering why this number can be more than 20% given the 2% cap on each position, it’s because some holdings outperform others and thus account for a larger percentage of the fund until it periodically rebalances.
Below, you’ll find a list of ECOW’s top holdings using TipRanks’ holdings tool. Many U.S. investors, myself included, are probably not familiar with each of these stocks, so an ETF like ECOW is useful for investing in a basket of these types of stocks.
ECOW is also extremely diversified across industries and countries. Unsurprisingly, as emerging markets are known for energy and raw materials, energy and materials are the largest industries represented here, as they both clock in with weightings of around 20%. Industrials also account for just under 20%, while information technology and communications services account for 12.8% and 12.1% of holdings, respectively.
China makes up the largest weighting by country, but its total weighting is still just under 20%. Taiwan and Brazil are the only other countries with double-digit weightings in the fund. Because China is a massive market, some emerging markets ETFs are dominated by Chinese equities, which isn’t necessarily a bad thing, but it does leave investors with more exposure to China than they may realize. Therefore I like ECOW’s well-rounded approach.
The Takeaway
ECOW has an effective strategy that screens for high-quality emerging markets companies, and it has outperformed its emerging markets peers, albeit slightly, over time. It offers ample diversification among its individual holdings, markets, and industries. Furthermore, it sports an attractive dividend yield of nearly 7%.
The one downside is that its expense ratio of 0.7% is higher than I would normally like to see, but funds focusing on emerging markets and employing more complex strategies than simply investing in an index are usually more expensive. For comparison, EEM’s expense ratio of 0.69% is almost the exact same as ECOW’s, but ECOW has been the better performer.
For U.S. investors and investors living in developed markets in general, I like the idea of adding ECOW to a portfolio while also holding one of Pacer’s U.S.-focused ETFs, like its flagship COWZ product. This enables investors to own many of the top U.S. companies by free cash flow yield while also gaining some exposure to high-quality emerging markets companies.
