Emerging Markets and ETFs

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Emerging Markets

The definition of Emerging Markets (EM) is a tricky one. I’ve often thought in the past about how can China still be defined as EM when it has grown so much over the last two decades and has become a key global player. The term ’emerging’ has connotations of something just starting. Although size does matter here there are many other attributes that need to be satisfied for a country to be defined as ‘developed’.

Depending on who is doing the defining, there are also variations in whether a country is classified as EM or not. Investopedia states that the International Monetary Fund (IMF) count 23 countries as EM whilst Morgan Stanley Capital International (MSCI) count 26 (see below) and there are several differences between the lists. The MSCI list includes countries such as Argentina, Mexico, Egypt, Russia, China & India. 

MSCI Emerging Market Country List

MSCI Emerging and Frontier Market Countries 2020

Frontier Markets

There is even a pre-emerging market classification, the ‘frontier nation‘; countries with a less advanced economy. Gold prospecting and carrying a trusty Winchester rifle comes to mind with a term like ‘frontier’. 

These countries are not yet sufficiently mature in certain attributes to be defined as EM. Frontier economies frequently don’t have developed stock markets and investment is mainly private or directly through start-ups and infrastructure. Some of the MSCI Frontier market countries include: Bahrain, Croatia, Ivory Coast, Kenya, Lebanon, Nigeria and Serbia.

Least Developed countries

If investing in Emerging Markets or frontier nations doesn’t get your heart rate moving sufficiently then there is an even earlier developmental classification known as the ‘Least Developed Countries” (LDCs).

The UN currently identifies 47 countries on the LDC list which is reviewed every 3 years.  The UN writes “Least developed countries (LDCs) are low-income countries confronting severe structural impediments to sustainable development. They are highly vulnerable to economic and environmental shocks and have low levels of human assets.” Countries that make this list get exclusive access to international support including development assistance and trade. Somalia, Afghanistan, Bangladesh & Haiti are some of the countries that make this list. 

Investing in Emerging Markets

The clear attraction for investing in EM or Frontier markets is the potential for growth but with higher returns comes higher risk. The less developed a nation is in terms of its political and financial infrastructure, the higher the expected volatility in thinly traded markets. Emerging Markets as an asset class has been somewhat out of favour during the last decade but if you believe in the principle of ‘reversion-to-the-mean’ then we can expect EM to perform well again in the near future. EM represents about 13% of the total global stock market.

The Callan Periodic Table of Investment Returns

The Callan consulting company produce the Callan Periodic Table of Investment Returns each year (below) and it visually shows how each major asset class has performed in each discrete year. The highest performing assets are at the top with the worst-performing at the bottom. A really useful infographic. I even use it as my desktop’s wallpaper to remind me of the importance of diversification!  As you can see from the last year, large-cap assets, in the dark blue boxes, have been in the top 5 every year during the last decade from 2010 to 1019 and was 1st or 2nd spot in 6 of the 10 years. In comparison, emerging markets have struggled and placed in the bottom 3 in 5 of the last 10 years. 

callan periodic table of investment returns

The Callan Periodic Table of Investment Returns

You can see the difference in the previous decade, 2001 to 2009 (no data for 2000 apparently). Emerging markets dominated the top half of the table and placed 1st or 2nd in 6 of the 9 years during that period.  Large-cap stocks in dark blue placed mainly in the bottom half of the table during the same period. Also worth noting how well Real Estate performed during that decade until the calamity that was the sub-prime mortgage lending crisis in 2007/2008. 

My Portfolio

I added iShares Dow Jones Emerging Markets Select Dividend ETF (SEDY) to my portfolio in April. The SEDY ETF passively tracks the Dow Jones Emerging Markets select dividend index which is an index of the 100 highest yielding companies in EM. As you can see from the index construction below there are various rules applied to filter and select the companies that will be included in the Index. It does this annually and the SEDY fund will make the same changes to continue to reflect what is in the Index. Important to note that each company that makes the selection is then weighted in the index by yield. 

Dow Jones emerging markets Index

Dow Jones Emerging Markets Select Dividend Index

The SEDY price has had a volatile time since its inception in 2011. The fund sold off by over 50% between 2013 and 2016. It had however made a strong recovery by the end of 2018 before moving sideways until the recent downturn. It’s recovered around 19% since the lows of March, similar to the broader stock market, but at 1396p it remains below its inception price which was around the 1640p mark.  

SEDY is the biggest holding in my portfolio, a smidge bigger than my Vanguard’s FTSE All-World High Dividend ETF (VHYL) holding, but these are early days as I develop this new income portfolio. As I write, my SEDY holding has increased by 6% since purchase. So far, so good – although my iShares core FTSE 100 tracker (ISF) has appreciated 10.7% during the same period.

SEDY: Key Statistics

SEDY is a fairly modest-sized ETF at £323m but popular in comparison to many of its competitor EM ETFs. The 8% yield is very attractive at the current price but we can expect this yield to drop significantly as a percentage and total dividend, as price recovers and global dividend payouts reduce due to C19.

It isn’t clear yet how much dividends will drop and of course, that will depend on how long C19 restrictions last. Likely estimates are in the 25-50% range.

As you would expect, this ETF is heavily titled towards value and contains zero growth-style stocks according to Morning Star’s style box. It has a surprisingly large number of small (20%) to mid-cap (52%) sized stocks which may hint at a good potential for future growth.

A brief review of the geographical representation also throws up one or two surprises. Taiwan (25%) and in particular Russia (19.5%) are heavily overweighted when compared to the standard MSCI Emerging Market Index. I think Russia makes up less than 4% of the global MSCI EM Index, Taiwan is typically around 13%.

The top 10 stocks contain several large mining companies with very hefty yields. Some as high as 10-15% annual yield. Historical earnings also look good but this is mining and it’s not having a good year so far. 

I like EM and I’m willing to tilt my portfolio towards income and value. Since its inception in 2011, SEDY has underperformed against the MSCI EM Index but that is to be expected as growth has outshone value as an investing factor during the last decade. 

EM is currently about 22% of my income portfolio and I intend to keep it at around 20% of my overall pot although I will diversify further with additional ETFs of Investment Trusts. The yields in EM are an attractive contribution towards my income portfolio and I’m betting on EM and value making a return within the next decade.

There are a decent number of alternative EM ETFs – any take your fancy over SEDY?

Thanks for reading.

Best,

Bollinger

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