BNP Paribas: Chancen durch Schwellenländer-Nebenwerte?

This paper examines the performance characteristics of smaller EM stocks and their deviations from both larger EM stocks and developedmarketstocks. An extensive study has been conducted, which was designed to isolate and interpret the historical drivers of EM small-capstock performance, as well as document the changing nature of the market relevance of various characteristics. It examines the predictivenature of a number of factors on historical stock returns, and also explores country, region and sectoral differences.

This survey of the analysis will begin with an examination of the structural impediments in indexing and will conclude with insights gainedfrom statistically dissecting historical performance data. In certain instances, the outcomes are quite surprising. In others, they conformmore closely to the conventional wisdom.
Why benchmarking or indexing leads to poor diversification with respect to company and geography in the emerging markets.

Typically, investors in EM equities lean toward emerging countries with large stock-market capitalizations and large-capitalization companies.

There are three reasons for this:

• index investing and benchmarking;
• dificulty in conducting proprietary research; and
• structural impediments to investing in certain countries or smaller companies.

As of April 30, 2015, over 55% of the MSCI EM Index was represented by its four most heavily weighted countries: China, Korea, Taiwan andBrazil. If Chinese A-shares achieve full inclusion in the index, China alone could represent about 45% of the larger-stock index. An interestingcomparison of the large and small-cap EM benchmarks (the MSCI Standard and Small Cap Emerging Markets indices) shows that theconcentration of the large-stock index is 19.11% in the top ten stocks by weight in the index, in contrast to the small-stock index, where thetop ten stocks equal 3.04% of the index. This diffusion in the small-cap index provides broader exposure to a more diverse range of companies.

The state-owned enterprise drag on EM performance

The large presence of state-owned enterprises (SOEs) is a major structural impediment in the EM index. State-owned companies are alarge component of the EM benchmark, particularly in countries such as China and India. These companies frequently do not act in thebest interests of their shareholders. Their index representation makes investing in EM large-cap stocks more challenging, as state-ownedcompanies often destroy shareholder value for strategic reasons or in the national interest. Data from the CEIC shows that returns on assetsfrom private companies have been consistently and significantly higher than those from SOEs. The EM small-cap benchmark contains muchless exposure to SOEs.

Global exposure in the EM index

Over recent years, a closer relationship has developed between emerging markets and the developed world. For investors, this reduces theopportunity to diversify through investing in EM stocks. The correlation between emerging countries and developed countries has increasedas their markets have become more global. This is particularly true of markets with global sector orientation, such as China, Mexico andTaiwan. At the same time, the country factor (the contribution of country to EM returns) has been declining. As the efficacy of countryallocation decreases, the alpha potential from macro allocation has shrunk and has moved closer to that of developed markets.

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