Recent tweaks emerging market indexes and economic growth rates show the changing nature of investing in the category.
The changes this year are part of a process that will likely continue over the coming years, so it behooves savvy investors to pay close attention.
“People need to realize that the emerging markets today are not the same as they were 15 to 20 years ago,” says Jay Jacobs, director of research at exchange-traded fund provider Global X in New York. The once fast-growing economies are maturing.
Investing in emerging markets through indexes. In June, MSCI, which manages the MSCI Emerging Markets Index, said it would start including so-called China A shares in the index. Historically, ownership of these shares was restricted to residents of mainland China. The A shares were previously excluded from the index by MSCI.
[See: 10 Great Ways to Buy Emerging Markets.]
With the change, China stocks now have a weighting of 29 percent of the entire index, up from zero in 1988 when the emerging markets index was launched, and multiple times the size of its 5.6 percent in the year 2000.
For investors, the implication of the growing China weighting is stark.
“If China has a problem then emerging market investors have a problem,” says Alper Ince, a partner and portfolio manager at investment firm Paamco.
If you are worried about investing in China then you might want to avoid investing in a broad emerging markets fund such as the Vanguard FTSE Emerging Markets exchange-traded fund (ticker: VWO). It has annual expenses of 0.14 percent, or $14 per $10,000 invested.
Instead, consider a fund that focuses on emerging market excluding China, such as iShares MSCI Emerging Markets ex China ETF ( EMXC) which has annual expenses of 0.49 percent, or $49 per $10,000 invested.
Even if China doesn’t worry you, it is worth noting that the problem with the scale of the country’s weighting could increase. “In the long run, if China becomes 50 percent of the index, then we’ll see investors looking at China separately and the rest of emerging markets as another asset class,” Ince says.
[See: 7 of the Worst Stocks to Buy for 2017.]
China will likely continue to grow its economy. Whether its weighting will increase will depend in large part on the strength of the other economies in the category.
Another change and more coming. Such index changes won’t be stopping anytime soon. Earlier this year, MSCI announced that it would include Pakistan in the emerging markets index, getting a leg up from frontier market status that includes less developed economies.
In the same release, MSCI also said that Saudi Arabia is under review for inclusion in the emerging markets index starting in 2018. The oil-rich country is now part of the frontier markets index, which includes less economically developed countries than those in the emerging markets category. Saudi Arabia is currently endeavoring to diversify its economy away from dependence on oil exports and is planning to sell a stake in the state-owned oil firm Aramco.
How the economies are changing. Indexes aren’t the only changes. The economies are changing too. Countries tend to expand quickest when they are starting on the road to economic development. But such fast growth cannot last forever — as an economy grows large, the growth tends to slow, and it can be dramatic.
China is a classic example. From 2003 through 2007 the economy grew at annual rates more than 10 percent each year. But starting in 2011, the rate of growth not only slipped into single digits but also steadily declined each year. In 2016 the economy grew 6.7 percent down from 9.5 percent in 2011, according to data from the World Bank.
What all this means is that while emerging markets investments were once fast-growing but volatile investments, perhaps they won’t be in the future. Countries that continue to grow will eventually slow down.
Investors should view these changes as a good thing in general.
“We are finding that most countries are doing well and some countries are shifting up to the next notch,” says Peter Andersen, chief investment officer of Fiduciary Trust Co. in Boston. And as some shift up in category, expect others to see their growth slow down.
The message for investors is simple. Yes, you can still expect to make money by investing in emerging markets, just don’t expect it to be a repeat of the returns of the last 30 years.
[See: Chinese ETFs: 9 Ways to Play the Middle Kingdom.]
You’ll more likely find higher, albeit riskier, returns in the next generation of fast-growing economies among the frontier markets.
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What Changes In Emerging Markets Mean for Your Investments originally appeared on usnews.com
