Interactive Investor

The emerging market ETF that avoids state-owned companies

20th September 2021 11:13

Tom Bailey from interactive investor

The consensus view is that such companies are often less efficient and less profitable. 

In the 20th century, many of the poorer economies of the world were convinced that government-owned industry was necessary for economic development. The government, according to this theory, should own and control heavy industry. This strategy had mixed success. In parts of Latin America, it broadly failed, while in parts of East Asia, notably South Korea, it was a success.

This approach to economic development started to fall out of fashion in the 1980s, with many governments and economists becoming convinced that markets and private enterprise were a better path to prosperity. As a result, many of the big state-owned companies were privatised.

However, the legacy remains. Many governments have been reluctant to sell off all their industrial assets in one go. Others have opted to semi-privatise certain industries, selling small ownership stakes to stock markets, while the government retains a significant stake. As a result, any investor in an emerging market index will have some exposure to such companies, often referred to as state-owned enterprises (SOEs). China is famous for this, but many other large emerging markets regions have their own SOEs.

The consensus view is that such companies are often less efficient and less profitable. As a result, they will also potentially have poorer share price performance. As Aneeka Gupta, director of research at WisdomTree, argues: “Over time, government influence on SOEs can lead to quite large, but fairly inefficient, businesses. This influence can stagnate the long-term growth potential of these companies in their respective emerging markets economies.”

As a result, WisdomTree has launched a new ETF which allows investors to invest in emerging markets without SOE exposure. The new ETF is called WisdomTree Emerging Markets ex-State-Owned Enterprises ESG Screened UCITS ETF (LSE: XSOE). It tracks WisdomTree’s own in-house index and has an ongoing charge of 0.32%.

WisdomTree defines SOEs as having government ownership of more than 20% of outstanding shares. The ETF also has an environmental, social and governance (ESG) screen, removing companies that are involved in controversial weapons, tobacco, thermal coal activities or those in breach of United Nations Global Compact (UNGC) guidelines.

WisdomTree has run a version of this ETF since 2014. Since October 2014, when the ETF launched, it has provided a 76% return to US investors (in dollar terms). In contrast, the US version of iShares MSCI Emerging Markets ETF has returned just over 50%.

Stripping out SOEs also changes the sector composition of the index. SOEs tend to be found in the “old economy” of emerging markets, such as financials, materials and other heavy industry. In contrast, tech and other digital-enabled companies tend not to be state-owned.

According to Gupta: “XSOE not only offers a distinct emerging market exposure by avoiding state-owned enterprises and having an ESG screen, but it also has an overweight to ‘new economy’ sectors such as information technology, consumer discretionary and communication services. New economy sectors have been among the key drivers of broad emerging market returns and overall growth of the market as some of the more traditional, ‘old economy’ sectors, such as energy and financials, have lost market share and continue to be the largest sectors of SOEs.”

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