By Todd Shriber & Tom Lydon
An oft-cited hazard of emerging markets investing, including buying stakes in some of the largest emerging market exchange traded funds, has been exposure to state-owned enterprises.
With those large weights to government-controlled companies, some of the largest and most heavily traded emerging markets ETFs deliver big weights to the financial services and energy sectors. Some new ETFs, including the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund (NYSEArca: XSOE), which debuted Wednesday.
True to its name, the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund excludes state-run offenders such as Petrobras (NYSE:PBR) and Russian oil companies, a strategy that could prove rewarding to investors going forward.
Although it is just speculation, it is not a stretch to assume that if XSOE was an older ETF, it would have outperformed some of the more widely held emerging markets ETFs. For example, Petrobras, Brazil's state-run oil giant, has plunged 83.3% over the past five years making it the worst-performing major oil stock in the world.
Amid plunging oil prices and scandal, shares of Petrobras are off nearly 44% this year. Colombia's Ecopetrol (NYSE:EC), also state-run though a smaller holding than Petrobras in most benchmark emerging market ETFs, has plunged 59%. Add to that falling oil prices, and economic sanctions from the West are expected to crimp 2015 dividends by Russian state-controlled firms, including major energy and financial services firms that are often found on the rosters of large emerging market ETFs.
"The first step in attempting to avoid SOEs is to understand where they are most common. The concentration of state-owned enterprises tends to be highest in countries like China, Brazil and Russia, which account for approximately 65% of the total state-owned enterprise market cap," said WisdomTree research analyst Tripp Zimmerman in a note out Wednesday. "On a sector basis, ownership tends to be concentrated among the public good sectors, such as Financials, Energy, Telecom and Utilities, which are among the most systemically important sectors to economic development."
By excluding state-controlled firms, the WisdomTree Emerging Markets ex-State-Owned Enterprises Fund ratchets up exposure to the emerging market consumer story, although the new ETF is a not a dedicated consumer fund. For example, XSOE's combined weight to the technology consumer discretionary and staples sectors, three of the fund's top four sector weights, is 46.5%. That compares with 35% to those sectors in the MSCI Emerging Markets Index.
Any company with more than 20% of its shares controlled by its home government is excluded from XSOE's underlying index. That index's eligible country universe is comprised of Brazil, Chile, China, Czech Republic, Hungary, India, Indonesia, Malaysia, Mexico, Peru, Philippines, Poland, Russia, South Africa, South Korea, Taiwan, Thailand or Turkey.
China, South Korea and Taiwan combine for just over 42% of the new ETF's weight compared with the 48% allocated to those countries in the MSCI Emerging Markets Index.
As Zimmerman notes, "ex-State-Owned Enterprises Index displayed higher growth expectations. Firms that have exhibited higher growth typically trade at premium earnings multiples, and they also tend to have lower dividend yields because they reinvest the majority of their earnings."
There have been instances where investors have been rewarded for taking on those higher multiples with emerging equities the state does not control. Just look at Baidu (NASDAQ:BIDU). Baidu, the Google of China, has surged nearly 450% over the past five years, a performance that the likes of Petrobras and state-run banks could only dream of.
XSOE Top Holdings
Table Courtesy: WisdomTree
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