Investors can take a look at active ETFs in emerging markets to target innovative companies and sectors primed to thrive despite inflationary headwinds.
In the recent webcast, Be Active: Beating Inflation with Innovation, David Dali, head of Portfolio Strategy at Matthews Asia, argued that the emerging markets and Asia, in particular, are attractive investment opportunities today. He noted that risk assets have re-rated downward, and as uncertainty over Federal Reserve rate hikes fades, the emerging markets and Asian markets, along with other risk assets, should recover. Asia ex-Japan valuations are now trading around 10-year lows. Foreign exchange currency risks also seem to be abating after the U.S. dollar peaks. Looking ahead, the growth cycle is more supportive for EM and Asia than for Europe and the U.S.
Meanwhile, China no longer faces the same headwinds that previously dragged down its markets. Regulatory headwinds may have peaked. China’s government is also cognizant of the economic slowdown and is taking steps to prop up its battered economy.
“Asia now dominates emerging markets and China is the most important country in Asia,” Dali said. “In my mind, the investment that can truly move the needle of the next 10 years is China.
When gauging the effects of the Federal Reserve’s interest rate hike regime on risk assets, Dali noted that Asia ex-Japan, especially the growth style, and emerging markets were the best performers during the early periods of the Fed’s previous rate hike cycle. Additionally, the best Asian sector performers include information tech followed by materials, energy, and financials.
Dali also highlighted the cheap valuations investors may find in Chinese markets. Specifically, the MSCI China is currently trading at a 53% lower price-to-earnings compared to its five-year max P/E. Looking at some of the various sectors, the communication sector is trading at a 79% discount P/E to its five-year max P/E, information technology is trading at a 62% discount and the consumer discretionary sector is trading at a 69% discount.
Michael Oh, portfolio manager at Matthews Asia, underscored the ongoing favorable demographics that could continue to support the long-term growth outlook in the emerging Asian economies. Specifically, Asia’s consumer market is expected to be larger than North America and Europe combined, with a projected 3.5 billion combined middle class population in Asia by 2030, compared to 354 million for North America and 733 million for Europe.
Oh also noted that Asia has been heavily investing in innovation over the years. Asia made up about 44% of total global research and development spending in 2018, compared to 25% for the U.S. and 21% for Europe. Asia also made up about 65% of global patent applications, compared to 20.4% for North America and 11.3% for Europe. Oh also pointed to innovative secular growth opportunities across Asia, including 5G adoption, fintech, data penetration, e-commerce, online entertainment, and more.
As investors turn to investment options to capture this growth opportunity, Matthews Asia has recently launched three active ETFs that focus on global emerging markets, Asia, and China, including the Matthews Emerging Markets Equity Active ETF (NYSE Arca: MEM), the Matthews Asia Innovators Active ETF (NYSE Arca: MINV), and the Matthews China Active ETF (NYSE Arca: MCH).
The investment strategies of Matthews Asia’s new active ETFs will be similar to those of the money manager’s existing mutual funds and will be managed using the firm’s fundamental research approach, which seeks to identify compelling investment opportunities that are expected to be able to generate above-index returns.
The Matthews Emerging Markets Equity Active ETF seeks alpha in global emerging markets, capitalizing on consumption and innovation trends. The portfolio takes an all-cap, company-first approach that emphasizes fundamental research over top-down country or sector allocation.
Dali highlighted the benefits of actively managed ETFs such as intraday liquidity, portfolio transparency, potential tax efficiency, allocations to countries and sectors, potential outperformance, flexibility to adjust factor exposure, manage regulatory risks, and the ability to compensate for index shortcomings.
In particular, Dali focused on the benefits of staying active when trying to access emerging opportunities in the developing economies. Specifically, he noted shortcomings of traditional beta indexing, such as the ability to capture growth, screen for quality and governance, invest in EM exposure outside of EM, diversifying small caps, access to next generation frontier companies, anticipate index rebalancing, manage inflation risks and access to IPOs.
“You can access China in many ways but go active. Go with an expert,” Dali said.
Financial advisors who are interested in learning more about innovative solutions can watch the webcast here on demand.