Emerging markets were the darling of investors as recently as the winter of 2019, but now find themselves once again unloved. The asset class has suffered under a barrage of tweets, tariffs, and uncertainty: The MSCI Emerging Markets Index is down 19% from its January 2018 peak, while the S&P 500 is up 5% over the same period.1 Exchange traded fund (ETF) flows have followed suit, with nearly $10 billion redeemed from EM equity funds in August alone, putting YTD cumulative flows close to flat.2
But just because EMs are down doesn’t mean they’re out. Indeed, signs of resiliency are appearing in the flows, which recently broke their losing streak: During the week of September 16, $700 million flowed into EM equity ETFs, primarily in country specific funds tracking China.3
Still, it is important to maintain some exposure to EMs, which offer access to growing parts of the globe with rising middle classes and potential diversification and growth. Here are four suggestions for investing in emerging markets:
Consider minimum volatility strategies. Investors concerned about volatility may want to consider minimum volatility funds, which potentially can smooth out the ups and downs of EM investing. Consider the example of the recent decline: The MSCI Emerging Market Minimum Volatility Index is down around 10% since January 2018, well outperforming the MSCI EM Index’s 19% drop.4
Tailor your EM portfolio around countries or regions. The EM landscape is changing: Saudi Arabia, Argentina and China A shares have entered the index, but counterintuitively it is getting more concentrated despite the new entrants. In just five years China’s weight in the MSCI Emerging Markets Index has risen from ~20% to nearly 35% currently and is expected to exceed ~40% at full inclusion of China A shares, according to MSCI as of August 2019.
But while China exposure is growing across portfolios, China risk is rising, growth and earnings expectations are being revised lower, and U.S./China tensions are escalating. The MSCI China Index is off nearly a quarter from its peak, dragging the rest of the EM index down with it. It’s possible that as China’s weight grows within the index, we’ll see treatment of EM ex-China comparable to that of Developed ex-U.S. or Asia ex-Japan.
One potential solution? Consider carving out China as a standalone allocation through an emerging markets ex-China strategy. More generally, investors can consider adopting a country-focused approach in their international portfolios. Concentrated risk exposures, low correlations across EM, and high return dispersion suggested EMs are well suited for such an approach.
Consider a broad-based exposure, but manage political event risk. Investors may want to consider a differentiated approach for tactical and strategic trading using broad EM exposures, making tactical trades around Federal Reserve meetings or geopolitical events.
Take a look at EM Debt as a potential complement to an EM equity portfolio. EM debtlooks attractive on a spread and yield basis and offers a complementary geographical exposure to the Asia heavy EM equity indexes. With central banks easing globally, investors are likely to look at EM debt in the renewed reach for yield.
Whether EMs come back in favor this week or next year, we believe most investors should consider some allocation over the long term to this important asset class. And ETFs – iShares Core MSCI Emerging Markets ETF (IEMG), iShares MSCI Emerging Markets ETF (EEM), iShares Edge MSCI Min Vol Emerging Markets ETF (EEMV), iShares MSCI Emerging Markets ex China ETF (EMXC), and iShares MSCI China ETF (MCHI) – offer the flexibility to implement that allocation through a range of applications.
1 Bloomberg, as of 9/25/19. Covers period 1/26/18 to 9/20/19.
2 Source: Bloomberg, as of 9/25/19.
3 Source: iShares by BlackRock, 4 strategies for investing in emerging markets, October 14, 2019 https://www.blackrockblog.com/2019/10/14/investing-in-emerging-markets/
4 Source: Bloomberg, as of 9/25/19. Covers period 1/26/18 to 9/20/19.
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