The emerging markets opportunity (part 2) — These aren’t your parents’ emerging markets

Canadian investors may be missing out on an investment opportunity. Over the past few decades, the world economic order has been shifting towards Asia, and many Canadians are failing to take advantage. A Globe and Mail analysis of Canadian balanced mutual funds, exchange-traded funds (ETFs), and robo-advisor portfolios found that the average weighting towards international stocks was 25 per cent.1 Given the MSCI EAFE Index (the benchmark for international equities) is dominated by Europe and the U.K., the emerging markets’ share in a portfolio is likely to be even smaller.

While the emerging markets asset class has been mostly overlooked by Canadian investors, we believe exposure to this asset class in an investor’s portfolio is likely to enhance diversification benefits and improve long-term returns. This shouldn’t be viewed as a “niche” investment or a “trade.” Specifically, the Asian emerging markets are a rapidly growing area of the world that we believe will only continue to grow in terms of economic importance in the years to come.

This is the second note of a three-part series (1. “demographics,” 2. “These aren’t your parents’ emerging markets,” and 3. “The investment opportunity today”) in which we discuss the contributing factors benefitting the region and the importance of having exposure to this dynamic asset class that’s evolving quickly and will experience some of the strongest growth worldwide.

Over the past two decades, the headquarters of the world’s largest companies have changed. Twenty years ago, approximately 70 per cent of companies in the Fortune Global 500, which measures the largest companies by revenue, were dominated by American and European firms, while only 30 per cent were represented by companies in Asia. Today, that breakdown is almost evenly split, with Asian companies accounting for nearly 45% and their American and European counterparts at 50%.

Further, within Asia and Japan, a geographical change in leadership has also occurred. Japanese companies were once the dominant revenue generators of the region, comprising slightly more than 20 per cent of the Fortune Global 500 companies globally while China only accounted for 2 per cent. Today, Japan accounts for approximately 10 per cent while China has seen its share of global companies increase from 2 per cent to a staggering 25 per cent. Positive long-term structural changes have allowed Asian companies to benefit and will allow the region’s companies to thrive over the coming decades.

Regional History of the Global 500

Source: https://fortune.com/global500/, as of December 31, 2020

In the past, emerging market Asian companies weren’t household names in North America. Today, while many names may still be unfamiliar, it’s impossible to go through your day without using one of the many products coming from Asia. The table below illustrates the top companies in the MSCI Emerging Market Index by market capitalization.

Unlike in the past, the top companies in Asia are recognized globally

Top 10 weights in the MSCI Emerging Market Index

Company

Country

Market cap (USD billions)

Index weight

Sector

Taiwan Semiconductor

Taiwan

507

6.3

Info tech

Tencent

China

451

5.6

Communication services

Alibaba

China

429

5.3

Consumer discretionary

Samsung

South Korea

344

4.3

Info tech

Meituan

China

138

1.7

Consumer discretionary

Naspers

S. Africa

104

1.3

Consumer discretionary

China Construction Bank

China 81 1.0 Financials

Reliance Industries

India 78 1.0 Energy

JD.com

China 73 0.9 Consumer discretionary

Ping Insurance

China 71 0.9 Financials
Source: MSCI, as of March 2021

The top weight in the entire index is Taiwan Semiconductor (TPE:NT). The company is the world’s largest manufacturer of semiconductors. Semiconductors, made from silicon, are in everything from televisions to medical devices; they’re in mobile phones, computers, and cars. Taiwan Semiconductor accounts for nearly 50 per cent of global market share in the semiconductor space. In a car, there are over 50 components that require a semiconductor, including seat position control, interior lighting, tire pressure monitor, remote keyless entry, and head-up display, to name just a few. Devices powered by silicon chips will only become a bigger part of our lives, and Taiwan Semiconductor is well-positioned to benefit.

Another company that you may have never heard of but likely know their products is Tencent, a multi-billion-dollar technology company that has the ability to reach an audience of billions around the world. Its messaging app, WeChat, has over a billion users in China and around the world. But its more than just a messaging app; think of it as an operating system where one can read the news, pay bills, order food, or run the operations of a small business.

Tencent is also the largest video game publisher in the world. It has a stake in the two most popular Battle Royale-style games: Fortnite and PlayerUnknown's Battlegrounds (PubG). The global video game industry revenues were expected to be approximately US$180 billion in 2020 according to IDC data, making it a bigger moneymaker than the global movie and North American sports industries combined. The target audience for video games is changing and Tencent is positioned to benefit from this trend.

Another company, Nio is China’s version of Tesla. In China, electronic vehicle (EV) prices are on track to reach parity with fossil-fuel-powered cars in the next four to six years. According to BloombergNEF, this will lead to approximately 25 million in electric vehicles sales in 2030, from about 2 million today. By 2030, there’ll be a new Big Three: China, the U.S., and India. These three nations are projected to account for 60 per cent of global vehicle sales, and Nio, along with other emerging market electric vehicle brands, is positioned for the generational shift.

We’ve seen a major change within the Emerging Market Index from a regional and sector allocation perspective. Historically, the emerging markets have had a much larger exposures to commodity producing countries. On January 31, 2000, the economies of Brazil, Mexico, and South Africa accounted for nearly 30 per cent of the Index. Today, that number is 10 per cent.

The change in regional exposure has tilted towards China. The Index started with a weight of 0.4 per cent, and today, nearly 40 per cent of the Index is exposed to China. Overall, China, India, South Korea, and Taiwan currently account for nearly 80 per cent.

This change of regional leadership has led to a change in sector exposure as well. The energy and material sectors once held a much larger influence over the Index. At its peak in 2008, those two sectors accounted for nearly 40 per cent of the MSCI Emerging Market Index, but it now represents approximately only 13 per cent, whereas the information technology, communication services, and consumer discretionary sectors have seen their share of the Index nearly double, from 26 per cent to 48 per cent.

Historical Sector Weights in MSCI Emerging Markets

Source: MSCI, as of December 31, 2020

We believe the change in sector composition of the Emerging Markets Index has also had an impact on its volatility. Historically, emerging markets have been more volatile than developed markets. However, this relationship has shifted recently as the geographic and sector makeup of the Index has changed, relying less on cyclical companies. The improvements in the region’s financial system and the increase in the number of companies with strong balance sheets has contributed to a more stable Index, in our view. When we measure volatility in terms of the annualized three-year rolling standard deviation, emerging markets have historically been more volatile than the S&P 500 or S&P/TSX Composite Indexes. However, this dynamic has changed over the past couple of years. Most recently, the three-year annualized volatility for the Emerging Markets Index is in line with the U.S. and Canada.

Annualized Three Year Rolling Standard Deviation (1990-current)

Source: Manulife Investment Management, Bloomberg, as of March 31, 2020

Are the emerging markets riskier? Well, the data would suggest that has changed. We believe as these companies continue to grow, they’ll exhibit risk characteristics similar to North America yet with greater upside potential.

Over the long term, world economic leadership is shifting towards Asia. This provides a favourable framework for emerging market equities. Are your clients positioned appropriately to take advantage of this investment opportunity? In our third and final part of this series, we’ll look at why it’s an opportune time to evaluate a client’s exposure to the emerging markets.

Macan Nia, CFA
Senior Investment Strategist

1 https://www.theglobeandmail.com/investing/markets/inside-the-market/article-heres-how-much-canadian-content-the-pros-are-putting-in-their/

A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.

Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.

The opinions expressed are those of Manulife Investment Management, as of the date of this publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use hereof or the information and/or analysis contained herein. Manulife Investment Management disclaims any responsibility to update such information. Neither Manulife Investment Management or its affiliates, nor any of their directors, officers, or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.

All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment, or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management Limited, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment, or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Unless otherwise specified, all data is sourced from Manulife Investment Management.

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Macan Nia

Macan Nia, 

Senior Investment Strategist

Manulife Investment Management

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Kevin Headland

Kevin Headland, 

Senior Investment Strategist

Manulife Investment Management

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Philip Petursson

Philip Petursson, 

Chief Investment Strategist and Head of Capital Markets Research

Manulife Investment Management

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