ETFs to Focus on an Important Growth Theme in the Developing Markets

Exchange traded fund investors looking to enhance their portfolios should consider the pioneering companies in the developing world and the fundamental changes taking place in the emerging economies.

In the recent webcast, The Next Wave of Digital Revolution Has Begun: The Rise of Emerging Markets, Kevin T. Carter, Founder and CIO, The Emerging Markets Internet, Ecommerce ETF (EMQQ) & The Next Frontier Internet & Ecommerce ETF (FMQQ); underscored the emerging opportunity in the developing economies, such as their favorable demographics that continue to support consumption-based growth and the fact that 85% of the global population resides in developing countries. Emerging markets and frontier markets are also home to some of the youngest demographics, with about 8.8 times the number of those under the age of 30 compared to developed economies.

Carter noted that middle-income consumers would take on a more significant role in the global economy ahead, especially in emerging countries where younger demographics thrive. According to McKinsey & Co. projections, an expected 4.2 billion people will constitute the consuming class by 2025. The emerging markets could account for $30 trillion in consumption, with developed markets making up $34 trillion. In comparison, emerging market consumers only generated $12 trillion in world consumption in 2010.

Investors have turned to popular broad emerging market funds to track widely observed benchmarks like the MSCI Emerging Market Index. However, these traditional EM funds are overexposed to state-owned enterprises owned and controlled by the government. Carter warned that these so-called SOEs are large, inefficient, have poor corporate governance, and may show widespread corruption. Among the largest or most popularly traded emerging market ETFs, 30% of underlying holdings are allocated to SOEs.

Looking ahead, Carter argued that investors should consider the growth of consumers or increased consumption trends in developing economies. Specifically, ongoing trends like the growing smartphone reliance are a significant catalyst in changing global consumption patterns. The rise of e-commerce has also paralleled the increased adoption of smartphone usage and the declining cost of the devices themselves.

Furthermore, developing economies’ adoption of smart devices and deepening internet penetration remain in the early phases, so there is still plenty of room to run. For example, while 82% of U.S. citizens have access to smartphones, Chinese smartphone users make up about 63% of its overall population, and India’s smartphone users only constitute 32% of its population.

As a better alternative to traditional emerging market funds, Carter highlighted a focused strategy, the Emerging Markets Internet & Ecommerce ETF (NYSEArca: EMQQ), which includes access to EM companies related to online retailers and the quickly expanding e-commerce industry. To be included within the ETF’s underlying index, companies must derive most of their profits from e-commerce or Internet activities like search engines, online retail, social networking, online video, e-payments, online gaming, and online travel.

The emerging markets are also enjoying a booming pipeline of new initial public offerings that include a range of new internet names to tap into the shifting consumer trends toward online shopping. Carter believed that the internet sector would support emerging market growth, especially given the shifting demand among emerging market consumers for smartphones and internet via mobile broadband. Consequently, EM e-commerce models are “leapfrogging” traditional models and are growing five times as fast as consumption.

However, Carter warned that EMQQ has primarily been a China story as China makes up 53% of EMQQ’s underlying portfolio, which doesn’t come as a surprise since China’s e-commerce sales are 3.9 times larger than all other emerging markets countries combined. However, this does not mean that investors should ignore the next frontier of consumer markets, like many frontiers and developing economies see a slew of new e-commerce or internet retail companies coming online.

Consequently, investors consider the Next Frontier Internet & Ecommerce ETF (FMQQ) to capture these more favorable trends in frontier markets. Strong economic growth, attractive relative valuations, and a concentration on consumer and internet names — the most attractive sectors — could be an excellent opportunity for investors for a more targeted approach to these frontier economies. Carter also noted that the next frontier population is 4.0 times larger than China, providing an even more extensive consumer base to support a growing internet and e-commerce industry.

Financial advisors who are interested in learning more about pioneering companies in the developing world can watch the webcast here on demand.