By Jeremy Schwartz
The emerging markets have been one of the bigger disappointments in terms of performance over the last few years, but there are pockets of opportunity, with some regions displaying fewer imbalances than others.
As I look at 2014, four months in, I find it important to break emerging market equities into different pieces. This isn't all that different from what people do in the United States, recognizing that to have a diversified portfolio, one must not only pay attention to a single index but also think in terms of different market capitalization size segments, as well as different value-tilted or growth-tilted strategies.
Average Annual Returns as of 3/31/14
Showcasing Diverging Emerging Market Equity Performance in 2014
•GULF Has Led the Way: Thus far in 2014, I've seen countries or regions with unique catalysts leading the performance picture. The Gulf region is different in that its outperformance can perhaps be attributed to MSCI's upgrade of the United Arab Emirates and Qatar into emerging markets. This will invariably improve liquidity considerations.
•EPI Has Benefitted from India's Equity Markets Up on Election Optimism: India is undergoing an important election in which the candidate deemed as potentially more "pro-business" has the lion's share of the momentum, and the equity market has been responding to the potential reform efforts going forward. India's equities have been breaking out to new highs, as I discussed in a prior blog post.
•DGRE and EMCG Have Rebounded Since Tough Markets of 2013: Looking at 2013, Indonesia and Brazil were hit particularly hard, especially from the perspective of their currencies. Thus far in 2014, I've seen a recovery in these markets as they've made progress on important reforms. Both DGRE & EMCG, therefore, faced a performance headwind as they launched but have since been turning around. EMCG, slightly positive over this time period, has additionally benefited from exposure to India-specifically to stocks within the Consumer Discretionary sector, recovering as I mentioned above. Unfortunately, EMCG's China exposure, particular in the Financials and Consumer Discretionary sectors, has been a headwind, accounting for its underperformance of DGRE.
•DGS Has Benefited from Focusing on Small Caps: One of the hardest-hit areas in emerging markets, since the 2008-09 global financial crisis, have been the large, state-owned enterprises , which people most readily associate with the Russian Energy sector, the Chinese Financials sector and the Brazilian Energy and Materials sectors. These are large, global operators, and by virtue of DGS's focus on small-cap stocks, they have been avoided. Of course, small caps have other characteristics that may cause greater potential for volatility over full market cycles, but from what I've seen recently, avoiding some of the most highly scrutinized state-owned enterprises has been beneficial.
•DEM Exposed to Some of the Least-Expensive Areas of Emerging Markets: The aforementioned state-owned enterprises, especially those in the Russian Energy sector and Chinese Financials sector, are some of the least expensive within the emerging market equity landscape. Since they are also some of the largest dividend payers in emerging markets, they are large exposures in DEM. Having the discipline to buy what is most inexpensive isn't always easy, but over longer periods it has certainly been a worthwhile strategy.
Blending Strategies for a Diversified Approach
A number of these emerging market strategies make very good complements to each other. I believe the Emerging Market Consumer Growth Fund, because its universe starts by excluding Energy, Materials and large Financials , could be a good pairing with and complement to DEM, which currently has large exposures to both Energy stocks in Russia and larger Financials in China.
So much of the emerging market story rests today with China and fears about China slowing down-even the inexpensive valuations in commodity stocks in Brazil or Russia can be tied to fears of China slowing down. China has been working to make progress on reform after its Third Plenum meeting last year, and this has invariably improved sentiment. Specifically, while I understand that these reforms are long-term in nature and will not immediately impact markets, I believe it is important for China's government to continually indicate that it is aware of the steps that must be taken over time. This announcement showed that China's leaders are cognizant of the plan required to help China progress on the path of economic growth over the years to come. For those contrarian investors looking for a rebound, DEM looks to be the deepest value play of the WisdomTree Funds that I show in this blog, while those looking for growth potential and higher-quality companies may want to consider EMCG.
Important Risks Related to this Article
Diversification does not eliminate the risk of experiencing investment loss.
Dividends are not guaranteed, and a company's future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.
Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Funds focusing on a single sector or region and/or smaller companies generally experience greater price volatility. Investments in emerging, offshore or frontier markets, such as the Middle East or India, are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention and political developments. Due to the investment strategy of these Funds, they may make higher capital gain distributions than other ETFs.
Jeremy Schwartz, Director of Research
As WisdomTree's Director of Research, Jeremy Schwartz offers timely ideas and timeless wisdom on a bi-monthly basis. Prior to joining WisdomTree, Jeremy was Professor Jeremy Siegel's head research assistant and helped with the research and writing of Stocks for the Long Run and The Future for Investors. He is also the co-author of the Financial Analysts Journal paper "What Happened to the Original Stocks in the S&P 500?" and the Wall Street Journal article "The Great American Bond Bubble."