Exchange traded fund investors looking for a way to enhance their investment portfolios should consider the compelling case for emerging markets.
In the recent webcast, How to Approach Emerging Markets; Value, Growth and Diversification, Emily Roland, Co-Chief Investment Strategist, John Hancock Investment Management, argued that the emerging markets are expected to dominate the global economy by 2050. Developing countries currently make up three of the top 10 global economies by gross domestic product, including China, India, and Brazil. By 2030, China, India, Indonesia, Russia, Brazil, and Mexico are expected to break into the top 10. India’s economy is also expected to be among the fastest growers, expanding 1401% from now through 2050.
However, many investors are missing out on this potential long-term growth opportunity. Roland pointed out a significant disparity breakdown between the percentage of world GDP and the percentage of world market capitalization. The emerging markets make up 39.7% of the world GDP but only makeup 11.5% of the total world market capitalization.
Looking ahead, Roland pointed to earnings growth as the ultimate driver of developing market growth. MSCI Emerging Market Index earnings growth is expected to be 44.1% for 2021 and 10.2% for 2022.
As we look at the emerging markets, Roland warned that many investors might be susceptible to concentration risks when relying on traditional benchmarks or index fund plays. For instance, the widely observed MSCI EM Index has a hefty 37.5% tilt toward China and 20.4% in information technology. The benchmark’s top ten holdings make up 26.6%.
Joseph Hohn, Senior Portfolio Manager, Dimensional Fund Advisors, argued that a multi-factor strategic beta approach could help investors better diversify risk. Like traditional asset diversification, factor diversification can help produce more consistent outcomes.
Specifically, investors can access the emerging markets and better manage the risks involved through a smart beta exchange traded fund strategy. The John Hancock Multifactor Emerging Markets ETF (NYSEArca: JHEM) tries to reflect the performance of the John Hancock Dimensional Emerging Markets Index, which tracks emerging market stocks and weights the securities on a rules-based process that may be referred to as multi-factor investing or smart beta.
The smart-beta ETF follows a rules-based selection process seen as a multi-factor approach, combining many factors in a single portfolio. Securities are adjusted by relative price and profitability. The underlying index may overweight stocks with lower relative prices and underweight names with higher relative prices. The indices can also adjust for profitability by overweighting stocks with higher profitability and underweighting those with lower profitability.
The underlying index implements market-capitalization adjustments where they increase the weights of smaller companies within the eligible universe and decrease the weights of larger names. The weighting methodology helps the ETFs follow a more equal-weight tilt with greater exposure to smaller companies than traditional market-cap weighted index funds in an attempt to capture the size premium and limit risks associated with high-flying, large-cap stocks that may be overbought in an ongoing bull market rally.
“Isolating the factors that drive higher expected returns for emerging-market equities,” Hohn said.
“Academic research has shown that stocks characterized by smaller capitalizations, lower valuations, and higher profitability have delivered higher expected returns over time,” he added.
Ryan Wellman, Product Manager, John Hancock Investment Management, said that John Hancock partnered with Dimensional Fund Advisors because it is one of the largest managers of active emerging-market U.S. mutual fund assets.
The John Hancock Multifactor Emerging Markets ETF provides a way to target a wide range of emerging-market stocks to access the breadth of the opportunity while emphasizing factors (smaller cap, lower relative price, and higher profitability) that academic research has linked to higher expected returns.
Financial advisors interested in learning more about the emerging markets can watch the webcast here on demand.