What is FEMS? (Pros, Cons, and Strategies)

Investors looking to tap into the potential of emerging markets often consider a diverse range of funds. One such investment vehicle is the First Trust Emerging Markets Small Cap AlphaDEX Fund, commonly known by its ticker, FEMS. In this blog post, we'll take a closer look at what FEMS is, its advantages and disadvantages, and some strategies to consider when investing in this fund.

What is FEMS?

FEMS is an ETF that focuses on small-cap companies in emerging markets. The fund's goal is to outperform traditional cap-weighted benchmarks by using the AlphaDEX methodology, which selects stocks based on a variety of growth and value factors.

Key Features of FEMS

• Emerging Market Exposure: FEMS invests primarily in small-cap companies that operate in emerging markets.
• AlphaDEX Methodology: This unique methodology selects stocks based on a range of factors, aiming to generate alpha, or returns above the market average.
• Diverse Sector Allocation: The fund diversifies across multiple sectors, thereby reducing sector-specific risks.

After analyzing stocks based on growth factors such as price appreciation, sales growth, and value factors like book value turnover, the fund selects and weights stocks intended to maximize performance.

FEMS Composition

FEMS is composed of a wide array of small-cap companies across different sectors and countries within emerging markets. This includes companies in technology, consumer goods, industrials, and more from countries like China, India, Brazil, and South Africa.

Pros of FEMS

High Growth Potential

One of the primary benefits of investing in FEMS is its high growth potential. Emerging markets are often characterized by rapid economic growth, and small-cap stocks within these markets can offer substantial returns.

Diversification

FEMS provides diversification both geographically and sector-wise. This reduces the risk associated with investing in a single country or sector, making it a balanced approach for investors.

AlphaDEX Methodology

The AlphaDEX stock selection process is designed to outperform traditional cap-weighted indexes. By focusing on growth and value factors, FEMS aims to generate higher returns compared to typical emerging market funds.

Cons of FEMS

High Volatility

Emerging markets are known for their volatility, and small-cap stocks can be particularly susceptible to market fluctuations. This results in higher volatility compared to more developed markets and large-cap stocks.

Higher Expense Ratio

FEMS has a relatively higher expense ratio compared to some other ETFs. The higher cost associated with the AlphaDEX methodology may reduce net returns over time, especially in a long-term investment horizon.

Currency Risk

Investments in emerging markets are subject to currency risk. Exchange rate fluctuations can significantly impact fund returns, adding another layer of risk to consider.

FEMS Investment Strategies

Investing in FEMS requires a carefully planned strategy, considering its higher volatility and the specific nature of emerging markets.

Long-term Investment Strategy

For those looking to invest in FEMS, a long-term investment horizon of at least 5-10 years is recommended. This allows investors to ride out market volatility and capitalize on the growth potential of emerging markets. Diversified exposure across multiple sectors and countries adds stability to this long-term strategy.

Regular Investment and Rebalancing

By regularly investing a fixed amount in FEMS, investors can take advantage of dollar-cost averaging, reducing the impact of market volatility. Periodic rebalancing of the portfolio ensures that the investment aligns with the initial risk tolerance and investment goals.

Complementary Investments

Given the high volatility of FEMS, it would be prudent to complement this fund with more stable investments in developed markets or large-cap stocks. This diversified approach can balance the overall risk profile of the investment portfolio.

Conclusion

FEMS offers an exciting opportunity to investors looking to tap into the growth potential of emerging market small-cap companies. While it comes with higher volatility and other risks, the AlphaDEX methodology and diversified sector exposure make FEMS an attractive option for long-term investors. By employing a strategic approach and understanding the specific challenges associated with emerging markets, investors can potentially achieve significant returns with FEMS.