In focus - Thought Leadership

A new approach to investing in emerging markets

Gavin Ralston and Kristjan Mee propose a new way of investing in emerging markets to benefit from the opening up of China’s capital markets.

15/03/2019

Kristjan Mee

Kristjan Mee

Strategist, Research and Analytics

Gavin Ralston

Gavin Ralston

Head of Official Institutions and Thought Leadership

In recent times, China has been front and centre of investors’ minds. In 2018 MSCI added China’s onshore stock market to its suite of global equity benchmark indices. Although the initial weight of A-shares is small, the decision is an important milestone. Investors will now have to decide how to access this part of China’s equity universe and how much to allocate to onshore equities. In this paper we present an alternative approach to investing in emerging markets which addresses this issue. We believe that a separate China A-share exposure in addition to an emerging markets allocation is better equipped to capture the potential of China than a purely global emerging markets strategy.

Before discussing the China investment opportunity we will make a few comments about investing in emerging markets more broadly. The decision to invest in emerging markets is usually based on the belief that faster economic growth in these countries will lead to higher investment returns. The reality is not as straightforward.

First, investors should be careful not to confuse the term emerging market with the term emerging economy. For example, several countries which feature in MSCI’s Emerging and even Frontier (the stage below emerging) market indices could be classified as advanced economies (Figure 1). South Korea and Taiwan are obvious examples.

The IMF ranks countries based on purely economic criteria, such as export diversification and the degree of integration into the global financial system. In contrast, index inclusion is governed by considerations about market size, liquidity and accessibility as well as economic status or prospects. Poor accessibility, particularly to the onshore market, is a key reason why Chinese equities have been extremely underrepresented in global equity indices.

Figure 1: An emerging market is not necessarily an emerging economy

* Argentina and Saudi Arabia will be promoted to the MSCI EM Index in June 2019.
** The West African Economic and Monetary Union (WAEMU) consists of the following countries: Benin, Burkina Faso, Ivory Coast, Guinea-Bissau, Mali, Niger, Senegal and Togo.
Source: IMF, MSCI and Schroders. Data as at January 2019.

 

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