The discipline of emerging markets investing – choosing investible targets in economies transitioning between developing and developed status – emerged in the 1980s after then World Bank economist Antoine van Agtmael coined the term. Since then, it has become a widespread investment practice as investors and asset managers seek to generate alpha from the opportunities of economic development, rising wealth and boosted consumption in such countries.
For investors hoping to gain access to these markets – but for whom the specialist knowledge of each emerging market was out of reach – index funds provided a key route in. Though there are many providers, since the turn of the millennium the MSCI Emerging Markets Index has been a constant benchmark of these economies’ performance, and a model for determining the next growth opportunity.
The composition of the index has altered during the past 20 years as the paths of the various economies that underpin it have panned out. Research carried out by State Street Global Advisors (SSGA) shows that China’s trajectory, perhaps unsurprisingly, stands out most: its weight in MSCI’s Emerging Markets Index swelled from 7 percent in 2002 to 16 percent in 2007 and 34 percent in 2020, boosted by the recent inclusion of more A-Share listed stocks.
At the other end of the spectrum, countries that were favored in 2002 – South Korea, Taiwan, South Africa, Mexico and Malaysia – have all seen their allocations fall in the intervening years. Between the MSCI Emerging Markets Index’s rebalancing on December 31, 2014 and December 31, 2019, South Korea’s rating fell from 14.3 percent to 11.4 percent, Taiwan’s from 13.3 percent to 12.1 percent and Malaysia’s from 3.8 percent to 1.8 percent. Instead, assets have been increasingly allocated to China, India and countries in the Middle East.
George Bicher, senior managing director and asset class CIO for global emerging markets equities at SSGA, says this is partly because it is becoming harder to equate a developing economy with potential growth. ‘Investors tend to look at emerging markets for growth,’ he explains. ‘But growth in the emerging markets space is often as elusive as it is in developed markets.’
Bicher cites research from the IMF in January. This predates the Covid-19 crisis but it projects that emerging economies will achieve 4.4 percent GDP growth. It also suggests that only four countries are expected to grow at an above-average rate: India, China, Indonesia and the Philippines.
‘There are many emerging market countries whose economies barely grow as fast as developed market countries,’ he says. ‘That’s not to say there aren’t good stocks in slower growth emerging market countries, but it makes stock picking more valuable.’
Beer, banks and cement
In fact, it appears that industrial trends have shaped growth far more so than national divisions. Once upon a time, emerging markets investment opportunities tended to be bundled together in very loose buckets: ‘beer, banks and cement’ was the term often used to designate those emerging markets assets that were generally the first to demonstrate sustainable growth.
Where banks, consumer goods companies and those that benefit from infrastructure contracts might be among an emerging economy’s early beneficiaries, leaders in the global technology sector are now the stars, whether involved in larger firms’ supply chains – such as Apple’s – or big names in their own right.
Since 2002 there has also been a broad rearrangement of the benchmark in favor of ‘new economy’ stocks. ‘China’s old-economy stocks tend to be large and often inefficient state-owned enterprises such as oil, gas and coal companies, while neweconomy stocks tend to be private sector companies such as Tencent and Alibaba,’ write SSGA’s researchers. Indeed, Alibaba makes up 7.1 percent of MSCI’s Emerging Markets Index’s weighting in 2020, and Tencent 5.9 percent.
Bicher notes that the two shifts in MSCI’s index – geographical and industrial – are intertwined. ‘The change in the benchmark, with the increased weighting of Chinese companies and large technology companies elsewhere in Asia – such as TSMC (4.7 percent) and Samsung (3.9 percent) –has intensified the focus not only in Asia but also in the IT space,’ he explains. ‘Managing emerging markets mandates now requires a keen focus on technology, including both the aforementioned hardware names but also firms that provide IT-related services, such as Alibaba and Tencent.’
This rings true for Egon Vavrek, director of global emerging markets equities at Dutch pension fund APG Asset Management. ‘When I started 20 years ago, it was all about extractive and commodity firms,’ he says. ‘There has been an evolution toward the IT service sector and internet technology.’