Emerging MarketsMay 24 2017

Emerging market investors should ‘beware the benchmark’ 

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Emerging market investors should ‘beware the benchmark’ 

Investors who buy emerging market shares through passive products risk being heavily exposed to backward-looking firms, an investment specialist has warned.

Luke Barrs, emerging market specialist at Goldman Sachs, warned investors to “beware of the benchmark” when it comes to buying emerging market equities.

Speaking during a Defaqto conference today (23 May), Mr Barrs said: “Unfortunately from a market capitalisation perspective, emerging markets indices have a lot of impaired assets.”

He said market cap weighted indices tend to be “backward-looking” because they capture the success stories of the past decade, rather than being positively positioned towards the future.

Mr Barrs warned that a third of the companies that make up these indices are backed by the State, meaning the interests are not necessarily aligned with investors.

These state-backed firms, he said, often pay out less in the way of dividends to shareholders than perhaps they should because the government wants to keep the profit.

The priorities of private enterprises, on the other hand, are more closely aligned with minority shareholders.

Focusing on the impact from a sector perspective, Mr Barrs said: “If you look at what has been successful historically and what is big in the market-cap weighted benchmarks, it is banks, hardware and energy firms.”

He warned of the lack of e-commerce, consumer and industrial businesses in the emerging market indices, using the MSCI emerging market benchmark as an example which is weighted heavily to so-called ‘Old China’.

“There are a lot of challenges and pressures these [Old China] companies will have to go through because of all the excesses built into the economy over the past few years.”  

“By going into a market-cap weighted passive fund, you are distorting your exposure because you are getting access to stocks which have done very well historically, but which aren’t positioned to capture that growth on a forward-looking basis.”

Mr Barrs also pointed to data on flows which suggests investors are not allocating to emerging markets on a strategic basis, despite their insistence that they are.

“Investors are chasing the performance, so any time it looks a bit tougher they are selling out of the asset class," he said, adding people tend to buy and sell at the most inopportune moment.

katherine.denham@ft.com