Fund Focus: the tricky job of ‘true’ emerging market investing

The exchange-traded fund (ETF) sector is constantly evolving, and new products often tend to reflect perceived demand. Want quantum computing, defence companies or a global portfolio of high-yielding shares? There’s an ETF - or several - for that.

What’s interesting, however, is that some launches reflect concerns about the state of markets. If we consider the US-heavy nature of the MSCI World index, that has led to the development of equal-weighted MSCI World indices to dilute Magnificent Seven exposure, as well as the emergence of MSCI World ex-USA funds.

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Now, with various emerging markets pulling ahead, we have seen further tinkering in this space. Note the launch earlier this year of the WisdomTree True Em Mkts ETF USD Acc GBP, which seeks to offer a more granular take on the region. 

The fund, notably, strips out exposure to China, Taiwan and South Korea, and thereby excludes some of the most prominent names in a conventional emerging markets tracker. You can say goodbye to Taiwan Semiconductor Manufacturing Co Ltd ADR, Samsung Electronics Co Ltd DR, SK Hynix, Alibaba Group Holding Ltd ADR and Tencent Holdings Ltd.

What you end up with instead is a lot of exposure to India and Brazil, which account for around a fifth of the portfolio apiece. 

Meanwhile, South Africa makes up 10% of the fund, with Saudi Arabia on 9.5% and Mexico on 7%. The fund has small allocations to Poland, the United Arab Emirates, Thailand, Malaysia and Indonesia. It arguably has more in common with the likes of BlackRock Frontiers Ord than the standard emerging market portfolio.

The fund might address a few valid concerns. First, investors may well dismiss the idea of an economy like China as “emerging” and be happy to focus on different markets in search of growth.

They may also worry about the sheer concentration of the average emerging markets fund: a quarter of the underlying market is currently in Taiwan, with TSMC accounting for roughly 14% all on its own. 

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If we look at active funds focused on Asia and the emerging markets, they can end up having huge exposure to TSMC, even if they have less exposure than a tracker fund. 

We meanwhile see around a quarter of the index tied up in Chinese shares, with almost 19% in South Korea. In the case of the latter, that reflects a lot of momentum for the market over the last year.

Investors may therefore want to take a more nuanced form of exposure to the region – be it by combining funds such as the WisdomTree ETF with an emerging market fund or even using single-country funds to get more granular exposure. 

We have dedicated funds when it comes to China, India and even South Korea, although they can be very concentrated and very choppy.

Note that other ETFs have tried to solve the problems of emerging market investors before. 

A regulatory crackdown sent something of a shockwave through the Chinese stock market in 2021 and this in turn inspired the launch of various ETFs that target the region, but without China.

Chinese equities have returned to form in recent history but if we look at one of these versus a conventional emerging market tracker, excluding it from the portfolio has certainly helped.

Source: FE Analytics. Past performance is not a guide to future performance.

But this fund comes with its own risks, and they seem to have grown. That’s because excluding China, which is such a big part of the index, makes what remains much more prominent. The iShares MSCI EM ex China ETF USD Acc GBP has around a third of its portfolio in Taiwan alone, with more than 26% in South Korea.

The fund has captured some of the big wins in the region over the past year, but might now be overly reliant on the same companies continuing to succeed.

It can therefore be an especially good time to check exactly what your Asia or emerging market fund is holding. 

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With many regions currently standing out, those who run active funds have big choices to make when it comes to where to back. Some have especially big TSMC positions, while we still get a few names such as Pacific Assets Ord that have a really distinctive approach, in their case largely avoiding China. 

Their particular approach has not paid off well at least recently.

With emerging markets continuing to ride high this year, investors may well be tempted to join the party. But the approaches on offer are very different – and many of the bets made are pretty big ones.