New Emerging Internet ETF Fills Big EEM Void

November 21, 2014

A new ETF canvassing online life in the emerging markets really is a distinct idea.

A new emerging market ETF with a focus on Internet use in the developing world is more than a catchy idea targeting a high-growth sector.

On the contrary, the new fund, the EMQQ Emerging Markets Internet & Ecommerce ETF (EMQQ), fills a big void in the current holdings of the exchange-traded fund market’s two biggest ETFs focused on the emerging markets: the iShares MSCI Emerging Markets ETF (EEM | B-97) and the Vanguard FTSE Emerging Markets ETF (VWO | C-84).

EMQQ, the new ETF, holds the very companies mostly excluded from the MSCI- and FTSE-based indexes that underlie EEM and VWO, respectively, due to technicalities related to some Internet-linked firms operating in emerging markets that choose to list their shares solely in the U.S.

By the way, EMQQ comes from Big Tree Capital, a firm headed by indexing-industry veteran Kevin Carter. What’s more, Carter’s business partner is none other than Burton Malkiel, the Princeton economics professor and author of “A Random Walk Down Walk Street,” first published in 1973.

Currently, only five of EMQQ’s 42 holdings overlap with iShares’ EEM. The overlap with Vanguard’s VWO is only three holdings.

The overlaps include Internet giants like Hong Kong-listed Tencent and Johannesburg-listed Naspers. But any significant overlap ends there.

Alibaba & Baidu

The point is that besides Tencent and Naspers, there are many important U.S.-listed emerging ecommerce and e-tailing companies that get thrown to the curb in many broad emerging markets indexes.

In the China space, I’m talking about companies like Alibaba, Baidu, JD.com, Vipshop SINA and Ctrip.com, just to name a few. Alibaba and Baidu alone would represent pretty hefty weightings in EEM and VWO if they were included.

By the way, EMQQ caps any single security at 8 percent to allow diversification and to minimize single-security risk from a handful of behemoth Internet companies.

Beyond China, EMQQ also offers up important exposure to other key local Internet players within their respective regions that are also missing from EEM and VWO.

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Beyond China: Latin America, Russia & Korea

For example, MercadoLibre is an online auction site and the largest e-commerce company in Latin America. The NYSE-listed firm is based out of Argentina, but it’s more of a Latin American consumer play. It’s got a major foothold in practically every Latin American country, and it gets a significant portion of its revenues from Brazil and Mexico. To be clear, MercadoLibre is not in EEM and VWO.

Moving on to Russia, local search engine Yandex is often dubbed the “Google of Russia.” The NYSE-listed firm has roughly a 60 percent market share of online search in Russia. According to internetlivestats.com, Russia’s Internet penetration is estimated around 60 percent, leaving a lot of potential for Internet growth.

South Korea Distinctions

EMQQ carries a hefty 11 percent weighting to South Korean firms. Korea is an interesting case, because the inclusion/exclusion of Korean stocks has more to do with country classification, rather than security assignment to an index.

Nonetheless, VWO specifically excludes South Korea because FTSE has classified the country as developed. EEM still includes South Korea as an emerging market, so the iShares fund does include locally listed South Korean Internet firms.

India, The Big Elephant

In terms of sheer potential for Internet expansion, India probably tops the list. It’s a country with a population nearing 1.3 billion people, but less than 20 percent of Indians currently have Internet access, according to internetlivestats.com.

Of course, the key word here is “potential.”

Investors have been frustrated for years at the snail’s pace of Internet expansion in India, the world’s second-most-populous country. Yet you have to ask yourself: How long will India stay at a 20 percent penetration rate as more Indians get access to smartphones?

There are only a handful of Indian Internet companies traded at the moment. EMQQ only holds two of them, but it’s poised to include more of them as they undergo initial public offerings.

Immediately coming to mind is Flipkart, an “Amazon-esque” online retailer and India’s largest e-commerce company. Even if Flipkart does an IPO, should it choose to list shares in the U.S., it may encounter similar issues that kept Alibaba out of MSCI and FTSE-based indexes.

That said, MSCI is currently consulting with investors on whether or not to include these “offshore” listed companies into their flagship indexes. The consultation, which ends on Nov. 28, could potentially lead to a methodology change and the eventual inclusion of these companies into EEM.

 

The Need For EMQQ

Here are EMQQ’s index weightings by country, based on holdings posted on EMQQ’s website.

Country EMQQ Index
Weighting (%)
China 66.7
South Korea 10.9
South Africa 7.0
Russia 5.8
Argentina 4.4
Brazil 2.5
India 1.7
Taiwan 0.8

 

 

 

 

 

 

Source: emqqindex.com

For now, China accounts for two-thirds of the fund’s weighting. But looking ahead, EMQQ is poised to incorporate up-and-coming local e-commerce firms from emerging economies, which could change the current weightings.

Alpha Or Beta

Many investors might turn to EMQQ for momentum in a high-growth sector, but beyond striving for outsized returns, EMQQ can simply complement EEM and VWO, from a purely “beta” perspective.

In many respects, I see EMQQ filling the holes of EEM and VWO similar to the way the KraneShares CSI China Internet ETF (KWEB | B-21) fills the gaps in the iShares MSCI China ETF (MCHI | B-37).

For broad emerging markets investors, it’s really about owning the whole package, which, unfortunately, EEM and VWO falls short of (at least for now). EMQQ fills those gaps and offers consumer-focused companies that would otherwise dilute the overbearing hand of state-owned enterprises in most broad emerging markets funds.


At the time this article was written, the author held a long position in Alibaba (BABA). Contact Dennis Hudachek at [email protected], or follow him on Twitter @Dennis_Hudachek.


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