How can investors adapt to the new emerging market paradigm?
Investors who believe that the current trends in emerging markets are apt to continue must now become more discerning with their emerging market allocations. Investing into generic broad based market-cap weighted strategies may no longer be sufficient to achieve desired returns. We believe emerging market investors should either invest selectively through targeted country exposures, or pursue a GDP weighted solution that more accurately allocates to countries’ based on their economic importance.
GDP weighted funds are ideal for investors who prefer to maintain a broad EM strategy that does not eliminate complete country exposures. GDP weighting can reduce exposure to countries like Brazil, who have suffered from currency volatility and weak commodity prices, and provide an overweight to countries like India and China that have more developed capital markets.
Investors may also consider looking for alternative drivers of emerging market growth that have been excluded from older market-cap weighted emerging market indices. We have identified two major potential growth opportunities within the emerging markets that stem from China. These two opportunities are Chinese internet and technology companies, and mainland Chinese equities listed on the Shanghai and Shenzhen stock exchanges.
Many Chinese technology companies decide to list in the United States in order to attract a greater international investor base. Due to their U.S. listing they are excluded from the majority of emerging market indices even though they derive most of their revenue from China. U.S. listed Chinese companies have returned 16.3% year to date as of 4/30/2015.8
Historically the mainland stock exchanges have been cordoned off from investors outside of China. Over the past two years China has accelerated the opening up of its economy by expanding its Renminbi Qualified Foreign Institutional Investor (RQFII) program that allows foreign investors to move a set amount of money in and out of the mainland markets. China also implemented the historic Shanghai-Hong Kong Stock Connect Program, which allows for investors to trade stocks between Shanghai and Hong Kong. These reforms coupled with an increase in brokerage account openings by Mainland Chinese investors have caused the mainland markets to soar since the second quarter of 2014. The Mainland Chinese markets are up 33.8% year to date as of 4/30/2015.9
While the strong U.S. dollar, increased U.S. energy production, and decreased fixed asset investment in China have taken some of the luster out of emerging market investing, savvy investors can still find plenty of potential opportunities within emerging markets. We believe a GDP weighted approach to broad based emerging market investing paired with a China allocation that includes Chinese tech companies and mainland listed Chinese equities may better position investors for success in the new emerging market paradigm.
- S&P 500 Index: includes 500 leading companies and captures approximately 80% coverage of available large–cap U.S. equities.
- FTSE Emerging Markets Index: provides investors with a comprehensive means of measuring the performance of the most liquid companies in the emerging markets
- MSCI Emerging Markets Index: is a float-adjusted market capitalization index that consists of indices in 21 emerging economies
- Bloomberg Dollar Spot Index: tracks the performance of a basket of ten leading global currencies versus the U.S. dollar.
- Naspers returns from Bloomberg as of 4/30/2015. According to MSCI Naspers was the largest constituent of the MSCI South Africa Index as of 3/31/2015
- Source: Thomson Reuters, “Shares in South Africa’s Naspers break key level as Tencent bet pays off” 4/13/2015
- MSCI South Africa Index returns from Bloomberg as of 4/30/2015. MSCI South Africa Index: is designed to measure the performance of the large and mid cap segments of the South African market. With 51 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in South Africa.
- U.S. listed Chinese securities represented by the FTSE China N Share All Cap Capped Index: Consist of companies incorporated outside the PRC, traded on the NYSE, the NASDAQ ,or NYSE MKT, and controlled by Mainland Chinese entities
- Mainland Chinese securities represented by the FTSE China A 600 Index represents the performance of the mainland Chinese market that is available to A share investors, and international investors via the QFII scheme.