2018 was a year of pain for emerging markets, but they appear on track for a bounceback.
Just take a look at the MSCI Emerging Markets Index, which posted an annual performance of -14.57% last year but has gained 9.23% for 2019 through July 31. It’s been a wilder ride for the MSCI Frontier Markets Index, which saw -16.2% performance in 2018 but has gone up 14.98% through July 31.
For ETF investors, the difference in labels is important to understand. “Emerging markets are more well known and are usually larger countries such as China and India,” wrote Wall Street Journal contributor Bailey McCann. “Frontiers are smaller nations, such as Vietnam and Nigeria, that have opened up to outside investment but are still in the early stages of adding listed stocks and formalizing rules that are investor-friendly.”
As evidenced in the MSCI indexes, frontiers are subject to sharper ups and downs than emerging markets. This, McCann explained, is because there’s likely to be less trading in the products of the smaller frontier economies.
Investors may want to get ETF exposure to emerging and frontier markets as they rally from last year’s plunge. But Binu George, portfolio strategist for emerging-markets equities at GMO, cautioned that ETF flows can exert a short-term impact on pricing and fundamentals as they hold large blocks of shares across many listed companies. But he does recognize that “ETFs are a net positive for investors and emerging markets” in the long run as EMs are opened up to more investment.
EM and frontier-market investors must keep an eye on fundamentals such as growth, balanced sheets, and management. Moves to diversify away from reliance on commodities should make such developing economies more attractive and make them more resilient. One case in point, the Journal noted, is Vietnam’s near-decade-long growth trajectory: the country has cultivated more than 1,500 publicly traded companies — a large number for a frontier market — and is seeing interest from global corporations that want to set up shop in Asia without getting entangled in trade disputes.
“For us, Vietnam is developed enough to support an ETF. It’s a way for investors to understand a country and see what it’s about without having to take an active position,” William Sokol, senior ETF product manager at VanEck, told the publication. The VanEck Vectors Vietnam ETF (VNM) has amassed US$469 million in assets, some US$120 million of which came in just this year.
Market liberalization is another fundamental for investors to consider. That was noted by WisdomTree Global Head of Research Jeremy Schwartz, whose firm focuses on former government-owned but now-independent, publicly traded companies through the WisdomTree Emerging Markets ex-State-Owned Enterprises Index.
“These companies are unique because they are usually well established and they point to a broader liberalization happening at a country level,” he said, expressing the firm’s conviction that the theme represents a long-term positive for investors.
ETF investors might also consider strategies focused on factors such as momentum and volatility. According to Nick Kalivas, senior equity product strategist at Invesco, mixing and matching different factors allows for a diversified portfolio that captures more sectors of an economy than a simple large-cap fund can.
“Ultimately, we’re at a point with emerging markets where investors can start building their portfolios in the same way that they do with stocks in the developed world,” Kalivas said.
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