The year’s best-performing EM ETF isn’t holding back

Jun 2nd, 2020 | By | Category: Equities

The best-performing emerging markets ETF year-to-date and over the past year shows no sign of holding back. And while the ongoing coronavirus epidemic has punished many EM equity funds, this fund is positively fizzing.

The fund in question is the EMQQ Emerging Market Internet and Ecommerce ETF, which trades in the US on NYSE Arca (EMQQ US) and in Europe in UCITS format on the LSE (EMQQ LN), Borsa Italiana (EMQQ IM), Xetra (EMQQ GY) and SIX Swiss Exchange (EMQQ SW).

The ETF provides targeted exposure to internet and ecommerce companies operating in emerging and frontier markets and has been designed to capture both the emerging markets consumer growth story – what McKinsey & Company call ‘the biggest growth opportunity in the history of capitalism’ – and the increasing digitalization of economies.

With coronavirus and accompanying social-distancing measures accelerating the adoption of internet-based practices across commerce, learning, and leisure activities, this combination of themes, both of which make compelling investment cases in their own right, is proving to be something of a sweet spot for investors.

The fund is up 39.0% over one year and 15.7% year-to-date. This compares to -4.0% and -14.4% for ETFs liked to the MSCI Emerging Markets Investable Market Index.

1-year ETF return performance comparison.

EMQQ was created by Kevin Carter, Founder and CEO of Big Tree Capital, a privately held investment firm focused on emerging and frontier markets.

EMQQ webinar | The Digital Economy in Emerging MarketsCarter, a veteran ETF entrepreneur and emerging markets investor, recently shared his perspectives on the fund with an audience of investors in a webcast, entitled ‘The Digital Economy in Emerging Markets‘, hosted by ETF Strategy.

Carter has always advocated a targeted approach to developing economies, noting that traditional broad market allocations suffer two significant disadvantages: exposure to state-owned enterprises and the exclusion of stocks listed on developed market exchanges.

He observes that SOEs are old legacy companies, primarily in the banking and oil sectors, which are typically plagued by inefficient management, poor corporate governance, and corruption. The looting of Petrobras, the Brazilian petroleum corporation, by senior government officials including two of the past three Presidents, epitomizes this problem.

While emerging markets consumer ETFs existed prior to EMQQ, Carter notes that they left out fast-growing technology firms that were often powerhouses for innovation and development in the consumer story. He immediately set out to design a strategy that would capture the interplay between consumer growth and technology themes.

The result of that process is the proprietary EMQQ Index, the fund’s underlying index.

The index includes companies that derive more than half their profits from ecommerce or internet activities within emerging or frontier markets. Such activities include online search, retail, social networks, video, gaming, and e-payment systems.

Unlike many emerging market indices, securities do not need to be listed in an emerging market with firms such as Alibaba, which is listed in the US, also being eligible. According to Carter, this significantly boosts the corporate governance profile of the index as companies need to adhere to the typically more stringent financial reporting requirements of their host exchange, such as NYSE or Nasdaq.

EMQQ currently contains 77 stocks, weighted by market capitalization with a single security cap of 8%, rebalanced semi-annually. China represents roughly 60%, although the index also includes innovative companies from other corners of the world. MercadoLibre, the Argentine company described by Carter as “the Amazon and PayPal of Latin America”, holds the second-largest weight of 7.7%, and has gained over 500% since EMQQ’s launch in November 2014.

Beyond these large public companies, Carter observes that EMQQ also provides indirect exposure to hundreds of small, high-growth private firms due to the significant role that firms like Alibaba and Tencent are playing as venture capitalists.

According to Carter, key to the success of EMQQ is the proliferation of cheap smartphones (often the first and only computers for emerging market consumers) and the growing access to the internet.

While smartphones and internet access are taken for granted in developed countries, they are almost still a novelty in emerging markets. Carter highlights the case of India where 75% of the population (or roughly one billion people) have yet to receive their first smartphone. Combined with emerging markets’ large young population, who are stepping up their consumption habits, Carter reiterates McKinsey & Co.’s assertion that this is the biggest growth opportunity in the history of capitalism.

Source: Big Tree Capital.

The investment case has, so far, been thoroughly backed up in the performance numbers. EMQQ was the best-performing emerging markets equity ETF in 2019 and has also led the field over three-year and five-year horizons.

The fund’s recent strong performance reflects the forces that have shaped a similar rally in developed market internet and ecommerce firms. All these companies are receiving a boost as the pandemic quickens the adoption of ecommerce, distance learning, telemedicine, food delivery services, and cloud technology. For Carter, he sees the growth of digitalization stabilizing at a higher level in the near future.

When asked whether EMQQ’s high aggregate P/E ratio would scare off value-oriented investors, Carter did note that P/Es are above average for emerging markets but stated that broad emerging market allocations represent “the world’s biggest value trap”. Referencing his denunciation of SOEs, he observed that valuations are low for a reason.

Furthermore, he noted that not only is EMQQ a secular growth story that warrants higher valuation ratios but the fund’s performance, while outstanding, has not come close to surpassing the revenue growth rate of its underlying constituents. As of the end of 2019, EMQQ’s five-year compound annual growth rate was 10.0% compared to a CAGR of 33.3% for the revenue of EMQQ index constituents.

All this points to further opportunities for investors.

Source: Big Tree Capital.

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