Emerging market equities have declined 5.4% since the U.S. elections on Nov. 8 (measured in U.S. dollars).¹ But they remain a significant source of the world’s stock-market capitalization and economic activity, constituting 11% of the global investable universe and 40% of the world’s wealth. How much do institutional investors want to allocate to this portion of the market?
The answer will vary, depending on how investors view the world.
For example, the true economic weight of a country or region within the world economy is best measured by using economic data, such as Gross Domestic Product (GDP), rather than financial data. GDP, a measure of the market value of all final goods and services produced, shows that emerging markets contribute 40% of the world’s wealth, as measured by the MSCI ACWI GDP Weighted Index.
Four views of emerging markets
Share of Emerging Markets in Various MSCI ACWI Indexes
Source: MSCI Research
Looking from where listed companies’ revenues are derived provides another possible answer to the question. This approach, which combines economic and financial data, reveals that emerging markets comprise 32% of global economic exposure. Why is this figure, as measured by the MSCI Economic Exposure Index, so much lower than the 40% measured by the MSCI ACWI GDP Index? Mainly, because many natural resources companies in emerging markets, e.g., oil and gas companies in the Gulf region, are not publicly listed and thus are not included in the Economic Exposure Indexes.
Of course, one can assess the economic value of emerging markets companies based solely on where their domicile and primary listing is. Using the companies’ full market capitalization is the most straightforward approach and yields an emerging markets weight of 22%, based on MSCI ACWI full company market capitalizations.
However, many investors choose to use a “free float” market capitalization benchmark — one that includes only those company shares in which one can invest. Emerging markets have a relatively low free float of 56%, which narrows their weight in MSCI ACWI to 11%, further narrowing the opportunity set.
So, what is the “right” allocation to emerging markets? Institutional investors can define the emerging markets opportunity set using different perspectives, ranging from pure economic to investability considerations. The answer is in the eye of the beholder.
¹ To Dec. 5, 2016