The most attractive emerging markets growth opportunities we see today are in companies that benefit from long-duration, secular growth trends. Establishing exposure to these companies through index-like allocations can be futile, however, as many mainstream emerging markets benchmarks tend to hold old-economy companies.
The highest-growth emerging markets companies historically have been innovators and disruptors that re-imagined the way people communicate, work, shop, and play. They have also profited from long-term growth catalysts, such as the growing middle class. However, many of these companies are underrepresented in popular emerging markets benchmarks. In fact, many emerging markets companies are the growth leaders of yesteryear—from financials, energy, materials, industrials, telecom, and consumer cyclicals.
Even growth sectors traditionally considered innovative and cutting-edge, such as technology, do not guarantee exposure to high-growth opportunities. The MSCI EM Index (Figure 1) has a significant weight in technology, and its top four holdings (Taiwan Semiconductor, Tencent, Alibaba, and Samsung) account for about 20% of the index’s market capitalization. These companies, however, have established businesses and are mostly incumbent technology leaders in Asia. They do not offer the long-duration, accelerating growth potential we see in other up-and-coming investment opportunities. About 6% of the index’s weight in technology is in hardware, where we see very little prospect for growth.
To seek passive or even broad-based exposure to emerging markets equities is to actively underweight some of the most dynamic and fastest-growing companies in the region.
Index sectors were grouped by Cyclical/Rate Sensitive, Defensive, and Secular Growth. Sectors with diverse holdings (consumer discretionary, communication services, and healthcare) were analyzed at the industry level, with each industry assigned to one of the three groups. Cyclical/Rate Sensitive includes financials, materials, communication services/diversified telecom services and wireless telecom services, energy, industrials, consumer discretionary (except internet and direct marketing), and textiles, apparel & luxury goods. Defensive includes real estate, consumer staples, health care/pharmaceuticals, and utilities. Secular Growth includes information technology, health care (except pharmaceuticals), communication services/entertainment, interactive media and services, media, consumer discretionary/internet, and direct marketing.
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