Liz Looks at: Emerging Markets

The Weight

With headlines about the spreading Delta variant, softening data in China, and civil instability in the Middle East, I thought this week would be a good opportunity to write about markets outside the US, namely emerging markets (EM), and delve into some recent patterns.

Perhaps the most dominant force on returns in EM indices or portfolios is the weight of each country in the index, but the title, above, also refers to the weight of geopolitical tensions and emerging markets’ less liquid and more concentrated capital markets.

Take a Load off China

As of July 31st, China made up 35% of the MSCI Emerging Markets Index. The next two largest weights are Taiwan at 15% and South Korea at 13%. That’s 63% of the index in three countries, all of which are in Asia. The other 37% is distributed across the 24 remaining countries.

To state the obvious here: any emerging market investment that tracks the index is going to be heavily influenced by a small number of countries and/or dependent on a particular region. This presents concentration risk and makes the investment more sensitive to the volatility that could arise in any one spot.

For example, over the last year, the MSCI EM index returned 13%, but with China removed, the index was up 30% over the same period. More specifically, a large portion of China’s poor returns over that year have occurred in the last 45 days. A double-digit difference in returns resulted from one country, which is something that could catch an investor off guard if they’re not aware of how dependent the index is on certain drivers.

Bottom line: know what you own and know if and where it’s concentrated. EM returns can turn on a dime and the volatility is not for the faint of heart.

Caught in the Fog

Also fogging up the window into emerging markets is the effect that geopolitical forces can have on particular EM companies. Much like Apple has a strong influence on US indices, Asian technology companies dominate the EM index, and many suffered as a result of China’s recent regulatory crackdown.

No market is immune to geopolitical shocks, but emerging markets are more sensitive and in some cases more controlled by governing bodies. What this means is that analysis of an emerging market investment has to include factors such as how easy capital flows into and out of the country, the level of economic development that’s present, size and liquidity of the market(s), and the geopolitical forces that could meaningfully change the investment outlook.

Hire the Band

That said, no risk, no reward—and emerging markets can be an important piece of a well-diversified long-term investment portfolio by offering interesting return opportunities. But this is a space where I would recommend using an actively managed investment vehicle like an exchange-traded fund (ETF) or mutual fund where there is an added layer of research on the investments that should theoretically reduce some of the risks mentioned above. Investing is all about taking the right kind of risks and being careful not to expose yourself to the ones that could have been avoided.

In case the title theme of this piece wasn’t obvious to everyone—one of my favorite songs is “The Weight” by The Band.

-Liz Young Thomas, Head of Investment Strategy at SoFi

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Communication of SoFi Wealth LLC an SEC Registered Investment Adviser. Information about SoFi Wealth’s advisory operations, services, and fees is set forth in SoFi Wealth’s current Form ADV Part 2 (Brochure), a copy of which is available upon request and at www.adviserinfo.sec.gov. Liz Young Thomas is a Registered Representative of SoFi Securities and Investment Advisor Representative of SoFi Wealth. Her ADV 2B is available at www.sofi.com/legal/adv.
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