Anthony Chan of BlackRock explains the role and value of emerging market ETFs by looking at trends in how investors are using them in their portfolios.
Date: Mar 2011
Tags: Emerging markets, Asset allocation, Portfolio construction, Liquidity
In terms of market knowledge, given that stock-picking is popular among Asian investors, people need to think about whether they are going for asset allocation or security selection. This is especially important with emerging markets, said Chan, of which there are currently 21 according to the MSCI definition.
Since having stock-picking ability across 21 markets is a big ask, a fund-based approach makes sense, explained Chan.
Then the question is why ETFs, he said. While mutual funds can also offer access to emerging markets, he said ETFs offer a broad set of products for people to invest in – either by region or country, or increasingly by sector or capitalisation.
Chan said another key reason to use ETFs is because some countries are difficult to access, For example, capital controls make it hard to access the China A-share market – and China is not unique in this way.
In terms of price discovery, it is difficult to access some of the emerging countries outside of the trading hours of the underlying, he explained.
Good examples of this were seen in India and Taiwan in 2010, he said, when markets were closed due to elections or other reasons. Yet ETFs continued to trade elsewhere on other exchanges.
Understanding the trade-off
According to Chan, it has become clear over the last couple of years that ETFs are certainly not all created equal. And advisers need to understand the differences between swap-based and physical structures, for example.
But in addition to assessing individual structures, Chan said it is also important to consider the trade-offs – whichever structure is used.
There is always a trade-off between performance and how closely a vehicle is able to track an index versus the costs involved and the amount of liquidity available, he explained.
And there is no right answer as to whether swap-based or physical structures are better, he added, because it is down to the each investor’s objective and how the trade-off works for that individual.
Chan said suitability of ETFs in general also depends on the trade-off over time depending on an investor’s holding period.
The impact of emerging market outflows
In relation to funds recently moving out of emerging markets, Chan said that while there have been broad-based outflows, they have to an extent been replaced by flows back into single-country emerging market exposures or narrower regional exposures.
This suggests investors are avoiding broad emerging market exposure and instead want to be more selective within this universe.
It also shows that investors now better realise that emerging markets means three very different economic areas – Latin America, the Middle East and Africa, and Asia.
Further, although a lot of clients want to know where flows are going to and coming from, Chan said it is important to bear in mind that a large inflow into a particular ETF doesn’t necessarily mean investors are bullish on that ETF.
Rather, he explained, if an investor has a bearish view on a specific asset class, they might look to short that via an ETF. Yet if there is not enough availability of borrow for that short to happen, there might be fund flows into the ETF in order to be lent out to cover that short.
