Emerging markets equities and exchange traded funds have been getting drubbed in recent months. Already vulnerable, on a broad basis, to potential changes in the Federal Reserve’s interest rate policy, emerging markets stocks were roiled this week when China decided to devalue the yuan.
Macro factors such as those and other themes, including but not limited to plunging commodities prices, the strong dollar and rising debt levels, underscore the importance of selectivity when considering rebound candidates among emerging markets ETFs.
The new Gavekal Knowledge Leaders Emerging Markets (NYSEArca: KLEM), which debuted last month, could prove to be an intelligent way of positioning for upside in developing world equities.
“The Knowledge Effect is the tendency of highly innovative companies to experience excess returns. The investment process aims to capture this market inefficiency using a proprietary methodology which capitalizes corporate knowledge investments, measures firm performance on a knowledge-adjusted basis, and selects investments in Knowledge Leader companies on the basis of knowledge intensity,” according to Gavekal.
At a time when Latin American equities continue struggling, KLEM is an attractive bet at the country level because the new ETF’s underlying index allocates nearly three-quarters of its weight to Asian companies. KLEM, which seizes on growing momentum for smart or strategic beta ETFs, can serve as a replacement for the traditional emerging markets ETFs advisors and investors have previously viewed as “core holdings.” [This ETF Excludes State-Run Companies]
KLEM also offers advantages over traditional, cap-weighted emerging markets ETFs, which are dominated by state-run banks and faltering energy companies, among vulnerable groups.
“Market capitalization weighting schemes are not in and of themselves inherently bad, but in the EM the bulk of the market capitalization is represented by yesterday’s “old economy”, state-owned sectors such as financials, energy, materials, telecom and utilities. Just like market capitalization weighting schemes, there is nothing inherently wrong with these sectors, but many (not all) of the companies that compromise them benefit to a large degree from things like accelerating infrastructure spending, rising commodity prices, a weak US dollar, falling corporate interest rates and a booming China,” according to a recent GaveKal research piece.
Importantly, KLEM’s state-owned exposure is scant as energy, financial services and utilities combine for barely more than 2% of the fund’s weight. Rather, KLEM is a credible play on the emerging markets themes of tomorrow, namely technology and the consumer. Technology and consumer sectors combine for about two-thirds of the ETF’s weight.
“So how does one gain cheap, diversified exposure to EMs, but do so in a strategic manner so as to maximize exposure to the sectors and companies that are most likely to see the highest growth rates while downplaying (not eliminating!) exposure to the sectors that are most likely to retreat? The obvious answer is to explore the precious few diversified EM ETF offerings that have an outside-the-box methodology that afford investors an opportunity to participate the high growth areas of EMs. One has to venture outside of the largest ten ETFs by AUM to find the ones that offer diversified EM exposure in a much more intelligent way,” according to GaveKal.
GaveKal Knowledge Leaders Emerging Markets ETF
