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14 Nov 2019

How to achieve precision exposure within EM

Zoltan

In case you missed our recent webinar on ‘Building better EM portfolios’, we’ve recapped some key points made by Fotios Kassianidis, Wealth Consultant at MSCI. He explains the significant structural differences between countries within the ‘EM’ block, and shows how you can tilt your EM portfolio in a meaningful way with some illustrative portfolio case studies.

There are several idiosyncrasies to factor in when building and optimising EM portfolios. As my colleague Jean-Maurice has alluded to, many stem from country choice: out of all of the building blocks of EM exposure, country choice has been the primary source of risk. EM countries all have unique characteristics which investors may choose to take into consideration. 

Country choice is an especially prominent topic at this moment, given the political dynamics between the USA and China. The exact implications of the ongoing trade disputes can’t be exactly quantified, yet we can still model the possible effects around the world based on certain assumptions.

Here we share a few highlights from our stress tests analysing how trade tensions between the world’s economic superpowers could spill over into the emerging markets. 

The structural differences between EM countries 

First, it is important to note that within the ‘EM’ block, there are significant structural differences between countries which are reflected in their equity markets. One indicative difference is varying levels of sensitivity to external market factors. For example, in Figure 1 below we compare the sensitivity of several EMs to the movements of developed markets (DMs) and the oil price sensitivity relative to the overall EM.

We see first that there is a wide range across the countries, and that big commodities producers such as Brazil and Russia are far more linked to DMs and the oil price than other countries.

Figure 1: Oil and Developed Market Sensitivities (relative to EM)1

                  chart 1

For illustrative purposes only. This is not a recommendation.

Interestingly, China has a far lower sensitivity to external fluctuations in the oil market and the world’s developed markets, compared to the EM average (the chart’s baseline). South Korea is in line with the overall EM on these measures, being as sensitive to DM movements and oil moves as broader EM, while Malaysia has minimal sensitivity to oil and slight negative correlation to developed markets.

In Figure 2 below, we get a clearer picture of the exposure of different EMs to the economies of China and the USA specifically. 

Figure 2: Economy Exposure to USA and China1

chart 2

For illustrative purposes only. This is not a recommendation.

China is understandably highly exposed to its domestic economy. Yet nearby Taiwan is more exposed to the USA, as is India, which exports a huge amount of IT services there.

With the knowledge of these differing structural characteristics and others, we can use single EM country indices to rotate portfolios and calibrate against unintended risks, such as a potential spillover coming from the ongoing trade disputes between China and the US. 

EM portfolios according to specific views

Case study 1: Reducing sensitivity to China

In this example we consider a hypothetical investor concerned about the potential impact of US trade actions on the Chinese economy. This investor could overlay single countries with lower volatility and lower reliance on China onto a broad EM allocation. We saw that India had exhibited strong and consistent low volatility bias relative to rest of EM, while Malaysia was characterised by low beta stocks and had a relatively low exposure to China.

When we then added India and Malaysia to an MSCI EM allocation, we saw a significant reduction in nominal exposure to China, and less exposure to the Chinese economy. 

chart 3

For illustrative purposes only. This is not a recommendation.

Case study 2: Overweighting China with a barbell approach

In our second case study example, an investor is looking for a high positive conviction about China’s long-term growth prospects and diversification potential. They may want to benefit from China and other emerging economies, without taking on excess risk.   

In this case they may choose to start with an EM ex-China block, adding separate allocations to single-country China, India and Malaysia. Overall nominal allocation to the three countries would go up, while from an economic exposure point of view there would be some differences with a pure EM index.

From a performance point of view, this portfolio could perform well in both risk-off and risk-on environments, while overall volatility is reduced meaningfully. This is unsurprising given the volatility profiles of India and Malaysia. 

chart 4

For illustrative purposes only. This is not a recommendation

These are just two hypothetical case studies, but they highlight how single-country indices could be used to tilt exposure meaningfully within EM, to take better account of the structural characteristics of different EM countries and build a more targeted and precise exposure to the world’s most dynamic, growing markets.

Fotios Kassianidis, Wealth Consultant at MSCI


1Source: MSCI. Average sensitivities over the last 5 years to the end of August 2019. Exposures based on MSCI GEMLT & EMM1 Risk Models. Past performance is not a reliable indicator of future results.

MSCI disclaimer
The MSCI data contained herein is the property of MSCI Inc. and/or its affiliates (collectively, “MSCI”). MSCI and its information providers make no warranties with respect to any such data. The MSCI data contained herein is used under license and may not be further used, distributed or disseminated without the express written consent of MSCI. MSCI does not issue, sponsor, endorse, market, offer, review or otherwise express any opinion regarding any fund, ETF, derivative or other security.


The view from Lyxor

Our expertise in Emerging Markets goes back to 2005, so if you’re looking to venture off the beaten path, let experience be your guide. Today, Lyxor ETF manages over €5bn in assets, and we offer more than 20 ways to invest, including broad, regional, single country and ESG exposures. We uniquely offer a broad EM ex-China ETF to help you build a more precise allocation towards the superpower.2

Explore our broad EM range or hone in on the countries that matter to you


Relevant ETFs

2Source: Lyxor International Asset Management, as at 30/09/2019. Number of exposures and assets under management includes Comstage funds. Lyxor’s first Emerging Market ETF was launched on 21/07/2005, the Lyxor China Enterprise (HSCEI) UCITS ETF. Lyxor credentials vs. peers refer to the European UCITS ETF market only.

This article is for informative purposes only and should not be taken as investment advice. The opinions expressed by Fotios Kassianidis are his own, as at October 2019, and do not necessarily reflect the views of Lyxor International Asset Management or Societe Generale. Statements relating to past performance are not a reliable indicator of future results. Capital at risk. Please read our Risk Warning below.

Risk Warning

This document is for the exclusive use of investors acting on their own account and categorised either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2014/65/EU. These products comply with the UCITS Directive (2009/65/EC). Société Générale and Lyxor International Asset Management (LIAM) recommend that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to client-services-etf@lyxor.com.

Except for the United-Kingdom, where this communication is issued in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658, this communication is issued by Lyxor International Asset Management (LIAM), a French management company authorized by the Autorité des marchés financiers and placed under the regulations of the UCITS (2014/91/EU) and AIFM (2011/61/EU) Directives. Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority).

The products mentioned are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them. Updated composition of the product’s investment portfolio is available on www.lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product. This document is of a commercial nature and not of a regulatory nature. This material is of a commercial nature and not a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

Research disclaimer

Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

Conflicts of interest 

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.

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