Exchange Traded Funds in Emerging Markets are an exiting opportunity for investors. The problem is that Emerging Markets are also notoriously volatile. Recent economic conditional such as a rising US dollar, higher inflation and tighter financial conditions have put pressure of Emerging Markets Equities. This could mean that valuations are now more attractive relative to historical prices and Developed Markets.
There are still a number of risk factors such as high debt levels in Emerging Markets, the rising cost of the dollar and interest rates make repaying this debt more difficult for Emerging Market Equities. Therefore, the challenge is knowing if Emerging Markets have now corrected to lower risk entry points or if they have further to fall.
With recession warning signs flashing in markets globally, it’s a challenge to see where markets have already corrected to entry points or lower risk and where they may fall further. Do Exchange Traded Funds in Emerging Markets offer an high potential returns or should they be excluded from your portfolio?
Disclaimer: This is not financial advice and you are responsible for your own investment decisions. When investing capital is at risk. This article may contain affiliate links.
What Are Emerging Markets?
Emerging market economies are classified in different ways by different observers. Levels of income, quality of financial systems, and growth rates are all popular criteria. The exact list of emerging market economies can vary according to the institution.
It can vary between 22 and 27 countries. For example, Morgan Stanley Capital International (MSCI) classifies 24 countries as emerging markets where as the FTSE Russell classifies 19 countries as emerging markets. Part of the reason for this is that countries may be upgraded or downgraded to Frontier or Developed nations.
There are of course, lots of Emerging Markets we could talk about. Below is an overview of some of the key Emerging markets in terms of size, growth and interesting trends. There are a number of funds you can also invest in Emerging Markets with. For example you can invest in emerging markets with Vanguard. As Vanguard offer an vanguard emerging markets stock index fund.
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Emerging Markets: China
China is an odd country to include as an Emerging Market being that it’s a key player on the global stage accounting for over 18% of global GBP. Despite this, China usually only accounts to 4% of a typical market cap-weighted portfolio, that tracks an index like the MSCI All Country World Index. China is also transforming into a potential leader in technology and other high-value products (e.g. Robotics). For investors it can make sense to view the country as an allocation in its own right, rather than within an emerging markets context.
According to Goldman Sachs “treating China separately may help create more efficient EM equity portfolios”. China’s weight in the MSCI EM Index has doubled over the past five years and could exceed 40% five years from now.
Emerging Markets: South Korea
South Koreans spends around 5% of GDP ($71trillion) on research and development. It invest ranks second in OECD countries for R&D spend. The Korean equity market, consequentially, is heavily tilted toward technology companies that upwards of 45% of the index. That’s because many of those companies are market leaders specialised and in-demand industries, like semiconductors. South Korea accounts for 20% of global production of Semi-Conductors. These are used in end products that range from cell phones and computers to luxury cars.
Emerging Markets: India
India accounts for just under 9% of global GBP. It’s GDP growth than investments or net exports, India aims to hold 3% of all global exports by 2027 and 10% by 2047. India could see itself become a world leader in the fight against climate change, with investment in renewable energy hit a record levels ($14tn) in India during the last financial year.
Emerging Markets: Brazil
The top exports of Brazil are Soybeans ($28.6B), Iron Ore ($26.5B), Crude Petroleum ($19.8B), Raw Sugar ($8.95B), and Frozen Bovine Meat ($6.69B). Brazil is second only to Australia in Iron Ore production, exporting over 380 million tons. (VC image). Brazil is the largest economy in South America and ranked eighth largest in the world by gross domestic product (GDP). With a newly elected leader set to make sweeping environmental and economic. Brazil could be set to become a real world leader.
Emerging Markets: Taiwan
Taiwan is dominating the global semiconductor trade and expects to grow it’s market share to 66%. Taiwan Semiconductor Manufacturing Co. Ltd. Is the world’s largest semi-conductor producer and it’s global share it’s expected to grow by 2% to 56%. TSMC already accounts for 0.54% of the Vanguards FTSE Global World portfolio. With global demand for technology increasing and the fields of Artificial Intelligence, Robotics growing, semi-conductors demand will also increase. With it, Taiwan’s economy.
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Exchange Traded Funds In Emerging Markets vs Developed Markets Performance
When you compare the performance of the Emerging Markets MSCI vs the Developed Markets MSCI you can see that it lags in performance. Not only that, but you have to tolerate a significant amount of extra volatility. In 2022 alone there has been a $2tn rout in Emerging Markets equities. This was driven by $70bn of outflows from Emerging Market Bond funds. Whilst Morgan Stanley sees this as an “exiting opportunity”, Goldman casts doubt on recovery.
The IIF predicted that year-on-year foreign portfolio flows to Emerging Markets could shrink by 42% to less than a trillion dollars in 2022. Prompting Luis Oganes (JPMorgan’s head of Global Macro Research) to state “If you are a global investor and you are not forced to be in Emerging Markets, to be honest it is hard to convince you to invest in the asset class at this time”.
According to Lazard Asset Management, just in In the third quarter, the MSCI Emerging Markets (EM) Index finished down more than 11%, bringing the year-to-date decline to 27%. By comparison, the developed markets MSCI World Index declined 6% in the most recent quarter, bringing this year’s decline to 25%.
Emerging Markets vs S&P 500
US equities in particular have surged in value, to the extent that some argue a bubble has formed. Should this be true then Emerging-market ETFs can hedge against the possibility of the U.S. market stagnating. The problem is that Emerging Markets often receive investment from US companies and when the US sneezes, the whole world catches a cold.
Outlook For Emerging Markets
The sharp drop in equity markets this year raises the question of where to find value and long-term opportunity. Bonds, usually considered a defensive asset have not been a safe place to hide, with all corners of the fixed income market affected. The yield on the Bloomberg Global Aggregate Index has risen nearly 250 basis points (bps) over the past nine months. This is the steepest and largest rise in the history of the index, exceeding even 1994’s epic rise.
Emerging markets may provide an under-priced asset classes, with valuations at some of their most attractive levels ever. EM economies may also be in better economic conditions than many developed nations. For example, public debt is 63.4% vs 121.6% in developed nations.
Strategists at Morgan Stanley have called the bottom for EM equities, forecasting a 14 per cent rise for the MSCI index by June of next year. Jonathan Garners Morgan Stanley’s Head of Global Emerging Market Strategy, is quoted by the FT as saying “It’s basically the beginning of a new cycle after a substantial drawdown in Emerging Markets equities and the longest bear market we’ve ever had — it’s really exciting,”
In his report, Garners goes on to say, “by the end of this month, the current bear market will likely become the longest in the history of the asset class, overtaking in days duration that triggered by the dot com bust in the early 2000’s. And after a more than 35% drawdown, the MSCI Emerging Markets Index is now trading close to prior trough valuations at only 10x price to consensus forward earnings.”
In an interview with Bloomberg Garner states;
Growth Expectations For Emerging Markets
Emerging markets investment returns have historically been closely tied to the rise and fall of commodities prices and global growth expectations. That’s because Emerging Markets economies are based on exports of commodities. Higher commodity prices support the economies of countries like Brazil, Chile, Qatar, and Saudi Arabia. As we have seen this isn’t limited to natural resources such as Oil or Iron Ore. It now extends to technological supplies such as semi-conductors.
Therefore, the outlook for Exchange Traded Funds in Emerging Markets is not all doom and gloom. Countries that export a large amount of commodities are benefiting from price rises. This means that although some Emerging Markets may pay for inflation, others will benefit. There is also the fact that these countries have lower Debt to GBP ratios compared to developed markets.
Many of these so-called Emerging markets are already major powerhouse economies that are underweighted in many portfolios. In China for example, despite short-term volatility JP Morgan forecast:
Onshore Chinese equity and government bonds returning a substantial premium over developed markets
Further capital market reforms and opening
Rising market participation by households as well as domestic and foreign institutions
A tilt by Chinese public and private equity toward new economy/growth sectors where the government wants to channel capital.
This leads then to conclude that “investors do not have enough exposure to Chinese onshore assets”. With “sustainable funds, green bonds and social impact bonds are fast-growing areas”.
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Exchange Traded Funds For Emerging Markets
Based on the opinions of Emerging Markets experts it seems like these stocks and bonds may be near the bottom. This would make them attractively priced for the future, offering strong growth returns.
There are a number of institutions that you can buy Exchange Traded Funds In Emerging Markets with. The fund structure, complexity and fees of the funds on offer can vary widely. In fact, ETFs for Emerging Markets often come at a premium, especially if they are actively managed.
You can usually build Emerging Markets into your asset allocation by buying into a Global Fund. The caveat to this is that the Emerging Markets allocation is usually < 10% of the total fund. This is why a market such as China will usually only account for around 4% in weighting in a global portfolio. These funds include:
Should you decide that you want to weight yourself towards Emerging Markets, then you may need an ETF for Emerging Markets. Vanguard and Fidelity offer a range of funds which should cover this need. In fact, Fidelity has over 780 EM funds available on their website. The below are a few of the index-based funds for investing in Emerging Markets.
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Emerging Markets EFT Vanguard
FTSE Emerging Markets UCITS ETF (VFEM) – The Fund employs a passive management – or indexing – investment approach, through physical acquisition of securities, and seeks to track the performance of the FTSE Emerging Index (the “Index”). The Index is comprised of large and mid-sized company stocks in emerging markets.
USD Emerging Markets Government Bond UCITS ETF (VEMT) – The Fund employs a passive management – or indexing – investment approach, through physical acquisition of securities, and seeks to track the performance of the Bloomberg EM USD Sovereign + Quasi-Sov Index (the “Index“). The Fund invests in a representative sample of bonds included in the Index in order to closely match the Index’s capital and income return.
Emerging Markets Fund Fidelity
Fidelity Index Emerging Markets Fund P Accumulation – The Fund aims to track the performance of the MSCI Emerging Markets (Net Total Return) Index. The Fund uses an ‘index tracking’ (also known as ‘passive’) investment management approach whereby it aims to replicate the composition of the index.
iShares Core MSCI EM IMI UCITS ETF USD (Acc) (EMIM) – The investment objective of the Fund is to provide investors with a total return, taking into account both capital and income returns, which reflects the return of the MSCI Emerging Markets Investable Market Index (IMI).
Fidelity Emerging Markets Fund China
- iShares China Large Cap UCITS ETF USD (Dist) (FXC) – The investment objective of this Fund is to provide investors with a total return, taking into account both capital and income returns, which reflects the return of the FTSE China 50 Index.
- HSBC MSCI China UCITS ETF (HMCH) – The investment objective of the Fund is to replicate the performance of the MSCI China Index (the “Index”). The Index is a market-capitalization weighted index designed to measure the performance of the largest Chinese companies.
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