Written by: Global Thought Leadership | November 10, 2017
Source: Bloomberg and Legg Mason,11/9/17. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
The chart shows the weights of the countries and territories represented by the 838 stocks in the MSCI Emerging Market Index, as of October 31, 2017.
The temptation for investors new to this part of the market is to gain exposure to these positive prospects through passive strategies – in the hope of buying the entire sector through one of a variety of well-established indexes.
But despite the care with which these passive indexes are designed, most share the problem of being more or less based on the relative amount of stock available for investment in each country.
Underlying this otherwise sensible is a capitalization-weighted structure, where the largest stocks have greater weight than others.
This results in a problematic skew in the direction of the countries with the largest equity markets. For example, China and South Korea together make up close to half of the MSCI Emerging Market Index,1 while Brazil and India comprise 8.6% and 7.0% respectively.
The result: a passive investment in EM could very well have strong country biases that represent neither the prospects for those countries’ stock market, nor the informed preferences of an investor focused on those particular countries – to say nothing of environmental, social and governance (ESG) considerations.
All of which strongly suggests that both the opportunities in EM investing and the well-understood inefficiencies of many of these markets can best accessed through an active, discriminating investment manager – rather than by an index which is both mechanical and inherently backward-looking.
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