Investors have looked to emerging market exchange traded funds to access potential growth opportunities in a low return environment and diversify an investment portfolio.
On the recent webcast, Define Your Emerging Market Smart Beta Strategy, Mike LaBella, Portfolio Manager at QS Investors, pointed out that the developing economies are projected to expand 4.1% this year and 4.6% in 2017, whereas developed economies are expected to grow 1.9% in 2016 and 2.0% in 2017.
In a survey of advisors on the webcast, the majority of respondents see the emerging markets accounting for a much larger percentage of global gross domestic product. Moreover, most advisors point to China as the dominant force in major indices and believe the Asian market could make up a larger slice of emerging portfolios as major indices include China A-shares.
However, LaBella warned that the growth story is not shared equally. For example, Peru has been the best performing emerging market year-to-date, surging 44.2%, while Brazil jumped 42.0%. Meanwhile, China dipped 4.9% and Greece fell 14.1% this year.
“Average spread between best and worst countries in emerging markets is 97%,” LaBella said. “Therefore it is important to invest across the broad opportunity set.”
Consequently, traditional capitalization-weighted indices may overexpose investors to emerging market risks. For instance, the MSCI Emerging Markets Index includes a 24% tilt toward China, and over half of its country weights are concentrated in China, Korea and Taiwan. Additionally, financials, technology, energy and materials sectors account for 62% of the index.
To diminish these contraction risks, LaBella advises investors to consider alternative indexing methodologies.
“An alternative, smarter allocation seeks to fully take advantage of opportunities within emerging markets and manage risks,” LaBella said.