Emerging markets has steadily falling out investors favor in the last couple years. The bleak outlook for the major emerging markets is in contrast to the golden years post the technological bubble burst and immediately after the financial crises where it became a safe haven for investors in a low growth world.
One of the most common axiom of investing is that themes or ideas will fall in and out of favor. When markets love an idea, asset prices which best represent those ideas will be bid up and likewise capital will flee when ideas fall out of favour.
When investors think of Emerging Markets, the first countries that come to mind are the powerhouse economies in Asia like China, Singapore and South Korea or BRICs. There are many more Emerging Markets in other regions which are not commonly written about including Mexico (Latin America), Poland and Hungary in Eastern Europe. Nigeria which just became the largest economy in Africa and Southeast Asia (Philippines).
The original thesis was globalization will support economic growth and create a middle class of consumers in these countries with higher disposable incomes. This in turn creates an opportunities as income rises will feed consumption and spending.
Since then this notion has been shattered where the most well known emerging markets such as Brazil, Russia, India and China (BRIC) has hit stumbling blocks. Brazil is a mess, the fall in oil price showed the commodity dependency of Russia. China follow crack down on corruption and slowing economic growth has inverted the idea that the economic gravity is shifting to Asia. India post the election of Modi with all its hopes has stalled.
Thematic investing is no different where investors apprehension to emerging market could create opportunity for value investors (like our selves at Dividend Investing) with longer horizons that can see beyond the current weak sentiment.
ASX Emerging Market ETFs
iShares, Vanguard and State Street each has their own ASX Emerging Market ETF. From our ASX ETF database we see the most liquid and popular funds are Vanguard FTSE Emerging Markets Shares ETF (ASX IEM) and iShares MSCI Emerging Markets ETF (ASX VGE).
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Australian investors can use these exchange traded funds to gain exposure to a broad basket of companies listed across number of emerging markets. These are passive index funds which means the return of the funds will match an Emerging Market index (like the ALL ORD or ASX 50 Index). The index.
ASX IEM ETF VS ASX VGE ETF
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Why use ETFs to invest in Emerging Markets?
Emerging markets is one of the investment styles where local knowledge is critical piece of the investment process. It is hard enough for fund managers to beat their local index, it is even hard if you overlay weak governance and other factors typical of these markets.
The advantage of using a market cap weighted ETF is the investments are mostly in large and well known companies which reduces the governance risk somewhat typical of investing in emerging markets.
One stand out fact for IEM and VGE is that they are well diversified with no single company will affect the fund performance. These are market cap weighted funds which means that the size of the holdings in the fund is based on the relative size of the company in the index. Hence the larger the company, greater the weighting.
Owning these ETFs give investors factor exposure which is the EM sector in general.
Typically, dividend yield are lower for Emerging Market ETFs. The low dividend yield is due to companies retaining earnings to fund their growth. The recent fall share prices has created opportunity to receive higher than historical dividend yield.
The common countries in these exchange traded funds include China, Taiwan, India, South Africa, Brazil and Mexico.
Alternative EM Options
So far we been focusing on Emerging Market ETFs which invests across multiple countries. Investors can also gain direct exposure to specific countries in the emerging markets by owning the market index of that particular country. For example if you think China is the place to be for the next decade then there are direct exposure option via investing in China ETF.
Unfortunately for Australian investors there are limited direct emerging market ETFs outside of Asian indexes. Outside pof specific instances where you think you have a direct view the wider market index would be preferred.
EM FX Risk
Currency risk is one of the largest risks investors should be aware of when investing in these funds. As these are unhedged ETFs. Any appreciation of the AUD would wipe away underlying equity increases.