EMERGING MARKETS OVERVIEW
Investors typically enter into Emerging Markets to further diversify their domestic equity portfolio, looking to gain exposure to the various return drivers in the space. However, while the growth opportunities within Emerging Markets continue to be rather vast and robust, it is important to understand the handful of drivers that have pushed the MSCI EM Index to recent highs, and the resulting concentrations that are building as a result.
Over the years, the MSCI EM Index has become increasingly more concentrated from a country exposure perspective. The weight of the top three countries has increased by 42% since 2009. China alone currently makes up 30% of the index and has contributed 40% to the Index’s overall return year to date.
This overconcentration significantly diminishes the portfolio diversification benefits that investors expect from the MSCI EM Index. Compared to the lower-weighted countries in the index, China, Taiwan and South Korea are among the countries with the highest correlation to developed markets such as the U.S. And since these three countries make up over 56% of the MSCI EM Index weight, the index is unable to deliver significant equity diversification.
Not only has the index increased from a country concentration perspective, sector concentration has also continued to build, particularly within Information Technology, which made up 13% of the index in 2009 and now makes up 28%. Compare this to Financials, the second largest sector in the index, which only realized an increase of 4% over the same period. The Information Technology sector alone contributed 41% to the Index’s overall return year to date.
Security Level Concentration
If we dive in a layer deeper, we notice that four individual technology names – Alibaba, Tencent, Samsung and Taiwan Semiconductor Manufacturing contributed nearly 30% to the Index’s overall gains year to date. Together these names currently make up 15%, resulting in a higher weight than most individual sectors in the MSCI EM Index
THE POTENTIAL FOR MISSED OPPORTUNITIES
While China and the Information Technology sector have delivered significant growth thus far, we believe it can be difficult to predict how long this growth will persist and which opportunities will end up being the next top performers. It is important for investors to consider the risks embedded in the MSCI EM Index, as well as the potential for missed opportunities outlined in the charts below.
The chart below plots the Top 10 Emerging Markets by Total Return over the 1-year trailing period versus their current weight in the MSCI EM Index. The cluster of countries towards the left vertical axis are examples of missed opportunities over the trailing 1-year period. These are countries that realized strong returns, however make up a de minimis piece of the index.
DBI EMERGING MARKETS TAKES THESE RISKS INTO CONSIDERATION…
The Emerging Markets DBI methodology diversifies away risk associated with large thematic country, sector and currency bets, providing a truly diversified emerging markets portfolio, allowing you to ride the changes in the underlying sources of economic growth premium.
QS DBI is designed to:
- Improve risk/returns over a market cycle
- Reduce market drawdowns through mitigation of concentrated bets
- Exhibit lower correlation of excess returns versus other quantitative and active equity strategies
- Reduce overall investment management fees versus traditional active strategies
As can be seen from the country and sector exposure charts below, Emerging Markets DBI maintains more balanced exposure across the opportunity set versus the market cap weighted index, ensuring investors are not significantly missing out on one opportunity set, while becoming overly reliant on another.
This material was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. It is intended for informational purposes only and it is not intended that it be relied on to make any investment decision. It does not constitute investment advice or a recommendation or an offer or solicitation and is not the basis for any contract to purchase or sell any security or other instrument, or for QS Investors to enter into or arrange any type of transaction as a consequence of any information contained herein. QS Investors does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. Except insofar as liability under any statute cannot be excluded, no member of QS Investors, or any officer, employee or associate accepts any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage whether direct, indirect, consequential or otherwise suffered by the recipient of this document or any other person.
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Please note an investor cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses, or sales charges.
Past performance or any prediction or forecast is not indicative of future results. No representation or warranty is made as to the efficacy of any particular strategy or the actual returns that may be achieved. The value of shares/units and their derived income may fall as well as rise. An investment is not a deposit and is not ensured by the Federal Deposit Insurance Corporation or any other government agency or by QS Investors or any of its affiliates, and is subject to risks, including possible loss of principal amount invested.
Any forecasts provided herein are based upon our opinion of the market as of this date and are subject to change, dependent on future changes in the market. In preparing this presentation, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. We consider the information in this update to be accurate, but we do not represent that it is complete or should be relied upon as the sole source of composite performance or suitability for investment.
Our investment strategies utilize proprietary research and quantitative tools to analyze securities and help us make investment decisions. While we maintain controls reasonably designed to protect the integrity and efficacy of the quantitative models and data used to formulate investment decisions, we can make no guarantee that the models and data will remain accurate and/or produce the desired or intended results over time.
Index providers (e.g., S&P, Russell Investments, MSCI Barra and FTSE) are the sources and owners of any index data contained or reflected in this document and all trademarks and copyrights related thereto. Unless otherwise indicated, this is QS Investors’ presentation of the underlying index data. Such data may include a redefinition of index sector and regional groupings in accordance with QS Investors’ unique classifications. The index providers are not responsible for the formatting or configuration of this material or for any inaccuracy in presentation thereof. Please note an investor cannot invest directly in an index, and unmanaged index returns do reflect fees, expenses, or sales charges.
QSCR 17353 (NOV 2017)