Winds of change favour emerging Asia
Five years is a long time in financial markets, for companies, countries and investors. It feels as though the rate of change in the last five years has been particularly rapid (although perhaps it always does). That is certainly true of emerging market equities as an asset class, and the changing nature of the benchmark (the MSCI Emerging Markets Index) is an interesting lens through which to view this change.
The most obvious change is in the country composition of the index. Israel, 2.7% of the index five years ago (the same size as Malaysia) with its then PPP GDP per capita of US$29,000, was promoted to developed market status by MSCI in 2010. Also promoted (from frontier to emerging in May 2014) were UAE and Qatar (PPP GDP per capita of US$58,000 and US$132,000 respectively – some emerging markets!).
Less happy was the demotion of Greece in 2013 from developed to frontier status following the economic crisis there. Tiny, illiquid Morocco was also downgraded out of the emerging market index.
Elsewhere, though, there have been seismic shifts in the emerging world. The collapse in commodity producers stands out. In 2009, the largest company in the index was Petrobras (4.2%). Petrobras (not held in the portfolio) now has a weight of a mere 0.8%. Similarly, Gazprom (1.8% to 0.8%) and Vale (3.0% to 0.6%) have seen sharp declines, reflecting the overall collapse in commodities (energy plus materials) from 29.3% to 16.0% of the benchmark. The commodity super-cycle was a myth.
The two stand-out winners have been South-East Asia and new technology companies. In South-East Asia (Indonesia, Malaysia, Thailand, Philippines), the eventual recovery from the Asian crisis of 1997 has seen big increases in credit, investment and consumption, an average annual GDP growth rate from 2008-13 of over 5%, and a reweighting in the MSCI EM index from 6.1% to 9.9%. During that period we have had a significant weighting in Indonesia (although we are currently zero-weighted), selective exposure in Thailand and Malaysia (still the case today) and limited exposure in the Philippines (where we are currently zero-weighted).
The other big winner has been new technology companies. At the top of the pile, and having been a major holding in the strategy since 2007, is the related pair of internet companies Naspers (South Africa) and Tencent (China). From a 2009 weight of 1.0%, they now represent 3.3% of the index, exceeded only by Samsung Electronics (also held). Many other technology companies have also grown relative to the index, from software and services, to devices, to chips and components.
A US economic recovery, with stronger domestic demand and tighter monetary policy, will have a differential effect on emerging market equities. We believe that EM technology companies are much better positioned than South-East Asian equity markets for that outcome.
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