A New Way to Tap Emerging Market Growth

May 5, 2009 3:18 am

Carl Delfeld

Carl Delfeld is head of the global advisory firm Chartwell Partners and editor of Chartwell Advisor . He served as a director on the executive board of the Asian Development Bank during the administration of President George H. W. Bush, and he is the author of The New Global Investor . Click here for more analysis from Delfeld, or to subscribe to Chartwell Advisor. click here.

Investing in Asian and emerging market growth is likely to be the dominant theme of the next decade. One can, however, argue about the best strategy and tools to tap into this economic growth, demographic change and rise of the emerging middle consumer class.

But first let me make a point about America. I have a new book coming out in June, The New American Century, that highlights America’s significant strengths and why I believe it will remain “first among equals” for a long, long time. Another major theme of the book is that America will do so by growing with Asia and emerging markets.

Here is a sample of some of my bullet points highlighting how the world is rapidly filling in from my presentation on the topic of “The Case for Asia and Emerging Markets”:

• Thawing of India and China - 40% of world’s population
• Emerging markets = 83% of world’s population
• BRIC = 17% world GDP
• China - FX reserves, $2.1 trillion
• Candidates for 2007 CFA Exam - Asia (52,900), US (45,400)
• apan’s bilateral trade with China larger than US
• India adding 25 MM each year to middle class
• ASEAN GDP exceeds $1 trillion•Last month of US trade surplus during Ford Administration•72 of Fortune 500 global companies headquartered in emerging countries

And the growing emerging market consumer class will have a profound affect on company growth and profitability and investment returns.

• Each year, 75 million people from emerging markets join the global middle class.
• By 2030, 90% of the world’s middle class consumers will reside in developing nations. These people will control over $6 trillion in disposable income.
• 25,000 more cars hit the road every single day in China.
• As many as 15 million new cell phone subscribers will sign up every month in India this year. That’s more new users each month than the entire population of Chicago.
• By 2012 there will be two billion new computer users in Africa, Latin America, Asia and Eastern Europe.
• Argentina’s number of Internet users has gone up 700% since 2000. And still only 6.4% of the population has broadband access.
• China alone consumes a third of the world’s steel. And in the next few years, they have plans to build 97 new airports and spend $292 billion on railways.

Much of this is driven by urbanization which is captured well in the following quote from the Wall Street Journal: “In the next 24 hours, approximately 180,000 people in developing countries will be moving from the countryside to cities such as Shanghai, Sao Paulo and Johannesburg. The same will happen tomorrow and every day thereafter for the next 30 years.

Now there are many ways for investors to tap into this growth. Stock picking, mutual funds, ETFs are just a few options but the interesting thing is that the geography of where a company is headquartered tell you increasingly little about where its growth is coming from. A small cap company in Ireland may be zeroed in on Brazil. Procter & Gamble gets 35% of its sales in emerging markets. Many Japanese multinationals are only alive because of their focus on emerging Asia.

Still, the purest play on emerging market growth are companies located in and focused on growing with their domestic economy and the region as a whole.

I have primarily used country ETFs and closed-ended funds as proxies for these emerging markets though they have shortcomings. Many country ETFs are dominated by just a few large companies and this can lead to overweighting specific companies and sectors.

This is why a welcome the launch of the first family of emerging market sector ETFs by Global Shares. The first few are expected to hit the market on May 9th and while these funds are not yet deemed effective by the SEC, the full menu is as follows:

• Emerging Global Shares Dow Jones Emerging Markets Titans Composite Index Fund EEG Launch May 09
• Emerging Global Shares Dow Jones Emerging Markets Basic Materials Titans Index Fund EBM Launch TBD
• Emerging Global Shares Dow Jones Emerging Markets Metals & Mining Titans Index Fund EMT Launch May 09
• Emerging Global Shares Dow Jones Emerging Markets Consumer Goods Titans Index Fund ECG Launch TBD
• Emerging Global Shares Dow Jones Emerging Markets Consumer Services Titans Index Fund ECN Launch TBD
• Emerging Global Shares Dow Jones Emerging Markets Energy Titans Index Fund EEO Launch May 09
• Emerging Global Shares Dow Jones Emerging Markets Financials Titans Index Fund EFN Launch May 09
• Emerging Global Shares Dow Jones Emerging Markets Health Care Titans Index Fund EHK Launch TBD
• Emerging Global Shares Dow Jones Emerging Markets Industrials Titans Index Fund EID Launch TBD
• Emerging Global Shares Dow Jones Emerging Markets Technology Titans Index Fund ETX Launch TBD
• Emerging Global Shares Dow Jones Emerging Markets Telecommunications Titans Index Fund ETS Launch TBD
• Emerging Global Shares Dow Jones Emerging Markets Utilities Titans Index Fund EUT Launch TBD

Using these emerging market ETFs allows a fund manager or investor to easily gain exposure to an undervalued sector without being preoccupied with geography. Chartwell will also use a ETF plus strategy whereby we layer some individual stock picks on top of a sector ETF.

Let’s look at one example using the Emerging Global Shares Dow Jones Emerging Markets Financials Titans ETF (EFN).

This financials emerging market sector ETF because the growing urban middle class throughout the region are underserved and the regions capital markets are underdeveloped.

Below are its expected top holdings and weightings.

• Dow Jones Emerging Market Titans Financials Index
• Company Name Country Capped Wght
• Industrial & Commercial Bank of China Ltd. China 10.00%
• China Construction Bank Corp. China 10.00%
• China Life Insurance Co. Ltd. China 8.99%
• Banco Bradesco S/A Pref Brazil 6.41%
• Banco Itau Holding Financeira S.A. Pref Brazil 6.31%
• Standard Bank Group Ltd. South Africa 3.92%
• Bank of China Ltd. China 3.88%
• Housing Development Finance Corp. Ltd. India 3.70%
• Itausa-Investimentos Itau S/A Pref Brazil 3.53%
• ICICI Bank Ltd. India 3.34%

The first thing you notice is the dominance of China, India and Brazil. This is consistent with the fact that these three countries account for about 40% of the MSCI Emerging Market Index.

I would balance this out by layering on top of this ETF five or so financial companies based in say Malaysia, South Korea, Indonesia, Turkey and Taiwan. I would also be open to including banks domiciled in developed countries such as the UK but focused on emerging markets. HSBC and Standard Chartered (up 18% during the past two days) would definitely be possibilities. This “core & explore” strategy may work for you as well.

Investors and investment managers can only look forward to the launch of this new family of emerging market sector ETFs . The possibilities and opportunities are endless.