MSCI’s Angled Anniversary Annals

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Index giant MSCI marked 30 years of the emerging market index with a detailed retrospective, while the paper also cast future direction with China’s “transformative characteristics” as full “A” share weighting is 40% of the benchmark. At launch it was 1% and now is 12% of the global equity gauge. Allocation rose from a low base at the start of this century as wider foreign investor access spurred infrastructure and trading improvements. In 2007 frontier and small cap indices appeared, with two dozen components in the core dominated regionally by Asia. The economic growth premium over developed markets is not as pronounced but remains intact, supported by sound fiscal, monetary and structural policies evolving over the period. In a sense the growth differential has come full circle, as the 1980s was also modest with the universe in the throes of debt crisis. Over history inflation conversely narrowed to advanced economy levels, with double digits currently an exception with the advent of independent central banks enshrining price stability. Net public debt is half the industrial world’s 80% of GDP, with a healthier current account balance. Valuations fluctuate with a price-to-book 20% discount the past two decades, and cross-sectional volatility as a standard deviation measure is lower. Correlations among emerging markets continue to emphasize diversification benefits despite the tendency to increase globally during scares. Currency risk analysis from 2010-17 shows that unhedged portfolios outperformed. Active factor investing incorporating momentum and yield produced 1-5% returns the last twenty years. ESG screening is common and enhanced results and “sustainability” portfolios could be standard in the next generation.

Since “A” shares were added a year ago, Chinese exchange liberalization and regulatory reform has advanced with a 20% of free float portion to be phased in by end-2019.Along with Korea and Taiwan, Asia will be over half the main index in the near-term, and helps explain regional preference in private equity as well according to the latest annual EMPEA trade group survey. Over 100 institutions from 40 countries, with almost $1 trillion in assets in the category, plan to raise near-term commitments. Southeast Asia is the most popular destination, followed by China and India, and Brazil and Africa round out the top five. At the rear are Russia, Turkey and the Middle East, and industry and size focus is in tech and the middle market. Fundraising was a record $90 billion for all funds in 2018, and the fraction of global portfolios should average 15% in the coming years. With the Abraaj collapse and scandal, due diligence is more intense, and proprietary questionnaires examine traditional financial and management concerns alongside cyber security, gender diversity and other issues. Asia gets 85% of allocation with China the leader at $35 billion collected last year. In contrast no Russia fund has closed since 2014, as political uncertainty is the overriding deterrent, unlike in Asia where exit difficulty is also less. The main obstacles there are steep entry valuations and crowded deals, according to the study. Past performance is the perennial main selection driver, and one-third of respondents believe ESG criteria and implementation are part of the evaluation.  Asia is viewed as the dominant tech play, and its currency stability compared with other geographies is another lure as EMPEA celebrates its own 15th anniversary.