The growing wealth of consumers in emerging markets is a compelling and easily understood investment thesis, so it is no surprise that several ETFs offer exposure to this specific theme.
But many of these ETFs struggled last year, underperforming the Vanguard FTSE Emerging Markets ETF (VWO).
Despite this underperformance, there are signs that the investment thesis remains intact. A survey of emerging market consumers by Boston Consulting Group found that consumer sentiment in countries such as Brazil, China and India remain strong, with recovering demand for goods and services.
Though the pandemic presents a continued risk as access to vaccinations in these countries remains limited, acceptance of vaccines is high, which bodes well for these economies once access is more readily available.
First Of Its Kind
The first ETF to offer targeted exposure to emerging market consumers is the Columbia Emerging Markets Consumer ETF (ECON), launched under the EGShares label in 2010. The fund tracks a cap-weighted index of 60 emerging market companies split evenly across three sectors—consumer staples, consumer discretionary and communication services.
ECON was successful in gathering assets, with over $1 billion in net flows by the end of 2013.
Courtesy of FactSet
These inflows were no surprise given ECON’s dramatic outperformance of VWO. From launch through the end of 2013, ECON gained 34.7%, while VWO rose by a mere 2.9%.
Since then, the fund’s assets have fallen to $131 million, while competing ETFs continue to enter the space.
The Indian Consumer
Some ETFs offer a more focused play on this theme. Another fund to launch not long after ECON was the Columbia India Consumer ETF (INCO), which debuted in August 2011. Rather than focusing on broad emerging markets, this fund solely focuses on Indian consumer sector stocks.
This focused exposure has allowed INCO to outperform, gaining 177% since its launch. While ECON’s 15% allocation to Indian equities has benefited from this rise as well, its effect has been diluted by the smaller allocation.
India’s outperformance of broader emerging markets has been going on for most of the past decade as the country’s citizens gained buying power, boosting these stocks.
However, the most recent divergence in performance has had to do with ECON’s weighting to China, which makes up nearly half of the portfolio via the Hong Kong market.
Courtesy of FactSet
This outsized allocation to the country is common in cap-weighted emerging market ETFs, the risks of which became evident in last year’s regulatory crackdown by the Chinese government.
With Or Without
One issuer in particular is acknowledging the opportunities as well as the risks of China’s weight in emerging markets by offering two versions of an investment theme—one with and one without Chinese exposure.
The Emerging Markets Internet & Ecommerce ETF (EMQQ) launched in 2014, tracking a cap-weighted index of companies producing most of their revenue from internet and ecommerce activity in emerging markets.
Access to smartphones and the internet is a key driver of the emerging market consumer, as things like mobile payments and ecommerce take hold within these countries.
China makes up over half of EMQQ’s portfolio, and performance over the last year has suffered due to this regional allocation as well as the ETF’s tech focus.
In September 2021, The Next Frontier Internet & Ecommerce ETF (FMQQ) launched, offering similar exposure as EMQQ, but notably excluding China. Korea is the largest country weighting in this fund, making up a quarter of the portfolio.
Though the launch was likely driven by events of last year, performance of FMQQ has lagged that of EMQQ since.
Past performance is no indication of what the future holds, though. Kevin Carter, founder of EMQQ and FMQQ, believes that both ETFs have a solid case for investment going forward.
FMQQ’s allocation to frontier countries presents significant growth opportunities going forward. “China’s ecommerce market, the most developed of the world, is getting close to 30% of all retail. The population-weighted penetration rate for FMQQ is under 5%. So you’ve got four times the [number of] people and one-fifth the penetration [of ecommerce],” he explained.
However, Carter also feels that the drawdown in Chinese internet and ecommerce equities is driven more by investor sentiment than fundamentals.
“Sentiment is important, and if it’s not noise to everyone else, that’s going to play out in the marketplace,” he noted. “But I think, long term, [the Chinese government] knows capitalism works. It’s hard to believe that they’re going to go away from it.”