Factors Supporting More Upside For Emerging Markets

Emerging markets stocks and exchange traded funds have notched another batch of impressive performances in 2017, building on last year's solid showing.

Some data points suggest the run for emerging markets equities and ETFs such as the Columbia Emerging Markets Core ETF EMCR is still in the early innings. As it is, the oft-overlooked EMCR is up 13.3 percent year-to-date and almost 15 percent over the past year. EMCR tracks the S&P Emerging Markets Core Index.

EMCR's underlying index “is an equal-weighted index designed to measure the market performance of up to 116 companies that S&P determines to be representative of all industries domiciled in emerging market countries, subject to a 15% country cap,” according to Columbia Threadneedle.

Rising GDPs throughout the developing world bode well for more upside for ETFs such as EMCR.

“The EM-DM GDP growth differential increased in 2016 for the first time since 2011,” Columbia Threadneedle said. “The International Monetary Fund (IMF) reports that emerging markets (EM) gross domestic product (GDP) grew 4.1% in 2016 vs.1.7% for developed markets (DM) — a 2.4% growth differential, up from 2.1% in 2015. The recently revised IMF forecast is for that differential to continue to increase every year through 2021.”

EMCR, which holds 112 stocks, differs significantly at the country level from rival, diversified emerging markets ETFs. For example, the ETF allocates 31 percent of its combined weight to India and Mexico. Those are the ETF's two largest country weights whereas most traditional emerging markets ETFs allocate 15 percent or less of their combined weights to those countries.

Conversely, EMCR's China allocation of 14.9 percent is small compared to competing strategies and the ETF features no exposure to South Korea and Taiwan, two countries frequently found in most diversified emerging markets funds.

“Historically, when EM GDP growth accelerates quicker than DM GDP growth (i.e., the EM to DM growth differential increases), EM equities have usually outperformed. In 2016 EM performance was +8.6 percent vs. DM +5.3 percent. Year-to-date, EM is +13.4 percent vs. DM +7.5 percent,” Colombia Threadneedle said.

With a combined 35.3 percent weight to consumer sectors, EMCR is more levered to recovering emerging markets GDPs than rival strategies that are often heavily allocated to slow-moving, state-run companies.