This week's ETF Brief continues the theme of the favourable outlook for emerging market equities, but examines how a small cap strategy can offer enhanced diversification. The MSCI Emerging Markets Small Cap Index has a lower exposure to China and provides more ways to capture the high growth in other leading Asian economies, including India and South Korea.
Emerging market (EM) equities have it all at the moment: better economic growth than domestic markets, the beneficiary of any US dollar weakening, undemanding valuations, and large catch-up potential. EM equities also offer valuable diversification of exposure from US equities. No wonder we have seen large inflows into both EM ETFs and more broadly into EM equities from institutional investors.
While we remain bullish on growth prospects for China, we know there has been disappointment with recent data releases. To capture the benefits of EM equities with less direct Chinese exposure, investors can consider the MSCI Emerging Markets Small Cap Index.
The narrow equity market rally, focused on the US and technology-related stocks, is causing some concern. EM equities can provide portfolio diversification benefits because of their relatively low correlations with US equities. We provided an in-depth explanation on the case for EM investing in a recent article.
Potential Benefits from EM Equities Include:
Investors are responding to this brighter outlook for EM. There have been large, consistent ETF inflows. Institutional investors (as measured within the State Street custody business) continue to add money to EM via individual companies and fund exposures versus most other regions. Despite these relative inflows, these investors still have underweight portfolio positions that remain close to extremes.
The biggest variable to sentiment is China. China's pace of economic activity (in trade, retail and investment) has been disappointing since the reopening of the economy from strict COVID lockdown measures. We remain China bulls and believe that the Chinese administration could boost growth with fiscal stimulus or easing monetary policy. High household cash levels are also available for consumption. However, investors wanting less reliance on this may consider investment strategies with less direct exposure.
EM small caps (as measured by the MSCI Emerging Market Small Cap Index) have various potential benefits but, compared with the MSCI Emerging Markets Index, have several compositional differences:
Comparison of Country Breakdown of MSCI Emerging Markets and MSCI Emerging Markets Small Cap
The MSCI Emerging Markets Small Cap Index has 1,864 constituents. The largest stock, Ecopro*, is a Korean manufacturer of cathode active materials and precursors for secondary batteries, having a weight of just 0.8% of the index. This company has been opening new plants in Europe to service the burgeoning electric vehicle market and the share price has risen more than four times so far in 2023.
While EM and smaller companies are often seen as more risky investment options, the different country and sector exposures offer diversification. Interestingly, even though volatility (in this case as measured by standard deviation during the past three years) is higher for EM in general compared with developed markets, the MSCI Emerging Markets Small Cap Index has been less volatile over this period than the large cap index.
*This information should not be considered a recommendation to invest in a particular sector or to buy or sell any security shown. It is not known whether the sectors or securities shown will be profitable in the future
Marketing Communication. General Access. For professional investor use only.
Investing involves risk including the risk of loss of principal.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
Diversification does not ensure a profit or guarantee against loss.
The above targets are estimates based on certain assumptions and analysis made by SSGA. There is no guarantee that the estimates will be achieved.
The information provided does not constitute investment advice as such term is defined under the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell any investment. It does not take into account any investor's or potential investor’s particular investment objectives, strategies, tax status, risk appetite or investment horizon. If you require investment advice you should consult your tax and financial or other professional advisor.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.
ETFs trade like stocks, are subject to investment risk and will fluctuate in market value. The investment return and principal value of an investment will fluctuate in value, so that when shares are sold or redeemed, they may be worth more or less than when they were purchased. Although shares may be bought or sold on an exchange through any brokerage account, shares are not individually redeemable from the fund. Investors may acquire shares and tender them for redemption through the fund in large aggregations known as “creation units.” Please see the fund’s prospectus for more details.
Investing in foreign domiciled securities may involve risk of capital loss from unfavourable fluctuation in currency values, withholding taxes, from differences in generally accepted accounting principles or from economic or political instability in other nations.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Past performance is not a reliable indicator of future performance.
This communication is directed at professional clients (this includes eligible counterparties as defined by the appropriate EU regulator or Swiss Regulator) who are deemed both knowledgeable and experienced in matters relating to investments. The products and services to which this communication relates are only available to such persons and persons of any other description (including retail clients) should not rely on this communication.
The views expressed in this material are the views of SPDR EMEA Strategy and Research through 2 June 2023 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
Investments in emerging or developing markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.
Investments in small/mid-sized companies may involve greater risks than in those of larger, better-known companies, but may be less volatile than investments in smaller companies.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU). This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
© 2023 State Street Corporation.
All Rights Reserved.