The MSCI Emerging Markets index has become distorted. Three tech heavyweights – Taiwan Semiconductor, Samsung Electronics and SK Hynix – now account for almost 30%. As a result, Taiwan and South Korea make up nearly half the index, and Asia totals 80%, while tech is 44%.
Returns have been strong lately, driven by the tech names – up 90%, 238% and 422% respectively in the last year. Still, this is not what investors think they are getting when they buy into emerging markets.
How to find domestic growth in emerging markets
Fortunately, there are trusts that offer more diversification. Utilico Emerging Markets (LSE: UEM) invests in infrastructure, utilities and related assets so it has no exposure to the tech giants. The geographic balance is also very different: Brazil is 22%, other Latin America 17% and Eastern Europe (including Greece) 9.5%. UEM is notably underweight China with just 9% there, mostly in Hong Kong, versus 20% in the index. “We find China very difficult, as regulations can change overnight,” says co-manager Charles Jillings.
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Stock selection is key as “mismanagement can destroy a good asset”, he says. “If we can’t find value in a country or sub-sector, we don’t invest.”
The largest holding is Orizon Valorização de Resíduos, a Brazilian waste management company, followed by International Container Terminal Services, which is based in the Philippines but operates in 19 countries.
The spread of the portfolio is further shown by holdings that include internet infrastructure company Korea Internet Neutral Exchange, Grupo Aeroportuario del Pacífico, which operates airports on Mexico’s Pacific coast, and Piraeus Port in Athens.
This gives UEM much higher exposure to domestic growth in emerging markets than the global, tech-focused index, often at attractive valuations.
Sonatel, a leading mobile phone company in West Africa, growing at 12%-13% a year thanks to rising customer spend but is trading at just 2.7 times cash flow, says Jillings.
The lack of tech means UEM has lagged the MSCI Emerging Markets over one and three years (though is still up by 14% and 34% respectively) but has returned 9.5% per year since 1995, ahead of its benchmark. The shares are on a 10% discount to net asset value (NAV) and yield 4.3%.
Back smaller stocks in emerging markets
Mobius Investment Trust (LSE: MMIT) offers a different angle, investing in “dynamic small and mid-sized companies” rather than the giants. The £136 million portfolio, which holds just 25-30 stocks, has minimal overlap with the MSCI Emerging Markets index.
While MMIT still has 38% of the portfolio invested in Taiwan and Korea and 31% in technology, this has been reduced in favour of industrials and financials. China accounts for less than 3% of the portfolio – an underweight that resulted in 22% underperformance of the MSCI Emerging Markets Mid Cap index last year but has been rewarded with 12% outperformance this year.
Meanwhile, India has risen to 28% this year. While foreign investors have been selling, domestic investors have been buying, notes lead manager Carlos von Hardenberg. The Nifty 50 index now trades 10% below its 2024 peak, even though economic growth is still 7.5%-8%, inflation is just 4% and interest rates are 5.25%. The rupee has lost 10% in the last year, but this is benefiting exports and import substitution.
Since mid caps have lagged large caps, returns of 33% over one year and 44% over three years are behind the MSCI Emerging Markets index, but mid caps are due a catch-up. The portfolio should offer 23% operating margins for the portfolio and annualised earnings growth of more than 45% over the next five years, estimates von Hardenberg. The shares trade on a 10% discount to NAV and yield 1%.
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