Why emerging markets can be rewarding for the long-term investor

● It is possible to invest in emerging markets (EM) by way of a low-cost index tracker. For example, Satrix offers South African investors an MSCI EM Feeder Fund and Old Mutual offers the Old Mutual EM ESG Index Feeder Fund.

Jason Swartz, the head of portfolio solutions at Satrix, says it is important to diversify your exposure in EM through a broad selection of countries. This can be cost-effectively achieved by investing in the MSCI EM index as it captures large, mid-cap and small-cap representation across as many as 26 EM countries. With 2,842 constituents, the index covers approximately 99% of the free-float-adjusted market cap in each country.

This index is fairly diverse and presents an alternative to the developed markets MSCI world index. The primary differences are the larger weighting to financial companies in EMs (23.5% vs 15.6%) and a significantly lower allocation to health care and industrials.

On the other hand, the MSCI EM has comparable exposure to technology to that of developed markets (14.3% in EM versus 15.8% in developed markets).

However, Lisa Haakman, a member of the EM team at Coronation Fund Managers, warns that though by investing in the MSCI EM index you gain access to some of the EM growth trends, it is primarily only to the technology sector. You are also exposing yourself to a number of very poor-quality companies.

“The top 25 shares in the index are concentrated in four sectors: technology, semiconductor and electronics manufacturing, banking and resources, many of which are state-owned,” she says.

Another reason to be cautious of investing in the index is that many of the Chinese technology companies operate via variable interest entities, a legal structure whereby shareholders control a company through contractual rights rather than through an equity ownership or voting rights.

The issue is that shareholders in variable interest entities have to trust that these contracts will be upheld, says Haakman.

Some of the most high-profile technology companies in the world, such as Alibaba, Tencent and JD.com, operate via variable entities.

Another reason to be cautious is the increasing inclusion of China A shares, listed in Shenzhen and Shanghai, which are not as closely regulated as Hong Kong’s stock market with its China H shares. In addition, many of these companies are still not reporting in terms of globally accepted reporting standards.