In spite of the recent underperformance of emerging market equities relative to developed market equities, it is reasonable to expect that the higher rates of economic growth in emerging markets will eventually translate into strong returns for investors. As well as higher growth rates, emerging markets offer the opportunity to gain diversification against developed market equity holdings, so most investors would agree that this is an area to which they must have exposure.
But what is the best way to gain that exposure? Is it through the standard emerging market indices?
According to our analysis, investors can gain a ‘purer’ emerging market exposure with better diversification by looking beyond the standard indices.
If we consider the MSCI Emerging Markets Index (EM), we find a heavy concentration in a small number of large cap stocks. These stocks include global brands such as Samsung and Hyundai and commodity stocks such as Gazprom and Vale whose products are priced on global markets.
If, however, we move our focus down the capitalisation spectrum to the MSCI Emerging Markets Small & Mid Cap Index (EMSMID), we find a broader, less concentrated universe with more domestic and less global exposure, as shown in the chart of the percentage of sales to developed markets from stocks in EM and EMSMID by sector:
In addition, EMSMID has a lower exposure to commodity-related stocks than EM and a higher exposure to consumer-related stocks which are well-placed to benefit from the spending power of the growing middle class within emerging economies.
We believe that emerging market small and mid cap stocks represent an exciting asset class, but we also recognise that there are difficulties in investing in a sometimes illiquid and poorly covered universe.
For this reason, we have developed an alternative beta strategy based on a systematic approach which we believe offers an attractive way to gain this exposure. The components of the strategy are:
- Meticulous liquidity screening to target consistently tradable stocks;
- A low volatility approach to focus on less risky names;
- The input of our Excess Return Model to select stocks with strong fundamentals, adding alpha in addition to smart beta;
- Portfolio manager oversight to control for risk factors which are outside the scope of quantitative models.
At DIAM, we believe in the exciting opportunities offered by emerging market small and mid cap stocks and we believe we can help our clients access these opportunities in the most efficient way.
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DIAM ASSET MANAGEMENT is the global brand name of DIAM Co., Ltd. (Tokyo) and its subsidiaries worldwide. The offices mentioned above are authorized and regulated as required within their respective jurisdictions as follows: DIAM Co., Ltd., by Financial Services Agency of the Japanese Government, DIAM International Ltd, by the Financial Conduct Authority, DIAM U.S.A. Inc., by the U.S. Securities and Exchange Commission, DIAM Asset Management (HK) Limited, by Securities and Futures Commission of Hong Kong, and DIAM SINGAPORE PTE. LTD., by Monetary Authority of Singapore.
This document is strictly for information purposes only and is directed to professional investors and eligible counter parties as defined by relevant authorities where DIAM’s offices are located. This document does not constitute any offer or solicitation of products or of services in any jurisdiction or in any circumstance that is otherwise unlawful or not authorized. |
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