Which emerging markets to pick?
When you’re investing in a passively managed fund, it is important to study the underlying benchmark. This gives you an idea regarding the geographic and sectoral allocation of the index which will be replicated by the fund.
The geographic allocation assumes importance as the underlying benchmark may be invested into stocks of a country which you may not be comfortable with. Given the definition of emerging markets, the index provider may have also provided exposure to a country which you may already be invested in, thus hurting your diversification.
Stephen H. Dover, Chief Investment Officer of Templeton Emerging Markets at Franklin Templeton Investments, explains that “it boils down to how one defines ’emerging market,’ and there is some disagreement about exactly what the criteria should be.”
Index providers like MSCI and FTSE look at various attributes like the size and liquidity of a market, foreign ownership, and a host of other inputs when determining the status of a country.
On the other hand, multi-lateral institutions like the World Bank look at more macroeconomic focused criteria when defining emerging markets.
Dover believes that “if you were to follow the World Bank’s standards as to which countries are classified as ‘high-income’ to determine developed-market status, you’d wind up with a very different set of constituents than the index providers for example, Qatar’s per-capita income ranks above that of Australia, Denmark, and the United States.”
How does the Templeton Emerging Markets Group create portfolios?
It is important to note that most of the mutual funds available for purchase are actively managed, which means that they do not passively track a benchmark, and instead retain the flexibility of making changes to their holdings as they deem fit. This applies to geographic and sectoral allocation.
The Templeton Emerging Markets Group also creates and manages portfolios actively. They use the bottom-up approach of managing portfolios. This approach involves focusing on the metrics of individual companies rather than macro trends impacting the countries of their domicile. A company’s financial health makes or mars its chances of making the portfolio rather than sector trends.
Dover explains that “we may even invest in a company that is located in a country considered to be developed if the bulk of its profits come from emerging markets.”
After explaining how his group manages investment portfolios, Dover delves deeper into what the group thinks emerging markets hold for the future. Let’s look at his views in the next article.