By Kemal Ahmed
Benchmark-cognisant emerging market funds that are overweight the big seven emerging markets are missing an opportunity to explore the full investable universe of 59 countries, which could translate both into investment returns as well as a recasting of traditional index-based allocations to Ems.
The big seven are a poor proxy for emerging markets, yet they dominate the emerging markets investment landscape. In our experience, the flow of investment capital tends to be heavily skewed toward these seven, with the remaining 14 countries in the MSCI EM receiving little dedicated investment in most traditional asset allocation exercises. Of 21 countries in the MSCI EM, the seven ‘large’ emerging markets account for approximately 80% of the index.
We believe traditional market capitalisation- based approaches inevitably limit the universe available to institutional investors, concentrating exposure in a handful of countries. The perception of economic and political risk associated with the large emerging markets has seen a dramatic shift over the past decade.
The acceptance of the BRICs as critical components of the global economy is testament to that. As a result, the traditional emerging market indices represent a very different proposition today to what they represented when they were first conceived. When the EM Index was launched in 1988 it represented only around 1.0% of the MSCI All Countries World Index (‘ACWI Index’).
Beyond the universe defined by market capitalisation-weighted indices, Horizon Markets – or markets that we believe to be next on the investment horizon – constitute an entire investable universe of around 1,200 stocks in smaller emerging and frontier markets, including Africa. This universe is under-represented, poorly understood, inadequately researched and in many cases excluded from investment. Horizon markets have better current account positions and debt levels. We also factor in political risk.
Our research has identified an initial investable universe of 40 “Horizon Markets” excluding the large emerging markets of Brazil, Russia, India, China, Korea, Taiwan and South Africa. Given their risk/return characteristics, these smaller emerging and frontier markets may provide a case for asset allocators to consider rethinking their traditional frameworks and the role of traditional indices.
Kemal Ahmed is a portfolio manager at Investec Asset Management
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