What Broad Emerging Market ETFs Lack

Sometimes interesting ideas come in small packages. The Emerging Markets Internet & Ecommerce ETF (EMQQ), launched in 2014, now boasts nearly $400 million in assets under management, but it remains relatively small compared to the multibillion-dollar emerging market ETF giants it stands against. As Kevin Carter—the issuer and the brains behind this one-ETF effort—will tell you, it’s been a tough road of education, explanation and die-hard conviction in a consumer growth story that fuels EMQQ’s investment case. But that story is what emerging market investing is all about, he says, even in the face of a global pandemic and economic collapse.  

ETF.com: The investment case behind EMQQ centers on what you’ve called the “great confluence” of smartphone usage, high speed internet access and a growing middle class with money to spend. We can’t argue the technology, but in the face of a global economic slowdown, how well does the consumer story in emerging markets hold up?

Kevin Carter: You have three very significant mega trends that are all colliding at one time. The first of those is certainly the emerging market consumer. There are two high-level bullet points that I tell people about emerging markets that I learned 15 years ago.

The first is that the positive part of the emerging market story, the thing that’s emerging, are the people. The middle class. The consumer. The GDPs, on average, in emerging markets, have grown twice as fast as those in the developed world. And those billions of people, 85% of the world’s people, are moving up. And they want stuff. This is a well-documented story that [consultant company] McKinsey calls, “the biggest growth opportunity in the history of capitalism.”

The second thing is that state-owned enterprises are a cancer on emerging market indexes, because they're not trying to grow share value. Those companies are a third of the MSCI EM index. If you counted the oligarchs too, it’s half the index. Traditional indexing is broken because of the state of enterprises.

When it comes to consumers, think about how the smartphone has changed our consumption. A lot of emerging market consumers are still getting their first-ever computer and smartphone. They are getting cheaper; fast internet is increasingly accessible—that consumption trend is very much intact. Sure, there's going to be a global recession, and the discretionary consumption will decline globally. But the three main trends of the story will live.

In fact, part of what's happening right now is the foundation of those trends becoming accelerated, because people are getting forced to use some of these things. Whether it’s goods, entertainment, education, financial services, you're seeing people forced to adapt to this. In some ways, emerging market consumers are skipping the traditional consumption infrastructure and leapfrogging to e-commerce. That happens to be the things that are the core of the EMQQ.

ETF.com: You could say EMQQ captures the biggest growth story in markets, and it’s also a defensive play right now given its focus on technology—the sector that’s enabled us to keep the economy running remotely. It’s often the best-performing EM ETF. Why isn't EMQQ the blockbuster fund of our generation? Is it the price? What gives when it comes to adoption?

Carter: Honestly, because investors haven't heard the story. It’s hard to get it out there. We’re a single-fund shop. We don’t have an army of salespeople. We outsource all of the pieces of creating the ETF and managing it. But we have three people that are marketing and doing operational things.

When people listen to the story, our batting average is close to 1000. The growth potential is real. Everybody’s got a smartphone. Everyone wants to consume. But I also think it’s just easy to check the box and buy the Vanguard or iShares ETFs. And because the allocation to emerging markets is generally small versus U.S. equities or developed, it’s hard for people to use what might otherwise be seen as a niche product.

Advisors ask me this a lot: “Well, how do I use this?” The natural thing for me to say, if I want it to sound palatable, is to suggest a core-satellite approach. Use the Vanguard FTSE Emerging Markets ETF (VWO)or the iShares Core MSCI Emerging Markets ETF (IEMG) for core, and then use EMQQ as a satellite. You can do that, and it might look cosmetically better; but you could just use EMQQ as well.

ETF.com: Emerging markets in general have been a tough sell for U.S. investors to begin with, right? Even harder when you get into narrower portfolios.

Carter: Yes. You have to remember that being in EMQQ for the last two years hasn’t been very fun.

I thought about my 20 months up until that point—2018 and the first three quarters of 2019. At the very beginning of the year, before we started a trade war with the second largest economy in the world, we saw the all-time high for EMQQ in the first couple months of 2018. We ended down for the year 30%. The revenue growth was over 30%, but the stocks were down, and so were we. I thought, Warren Buffett says you pay a high price for a cheery consensus. If everybody thinks everything’s great, then maybe you should be concerned about your valuation. Well, we had very much the opposite of this.

Sentiment plays a huge part in emerging market investing. All I do is talk to people about emerging markets every day. People were just decidedly negative. We hadn't had any creations in almost two years. And all of a sudden, Hong Kong happened, and creations started to come. This year started great. We had creations every day for the first two weeks. You could feel the sentiment shift to more positive. Then, all of a sudden, this virus showed up.

ETF.com: EMQQ’s strong performance but slow asset growth is an interesting case of entrenched investor behavior, perhaps. It just goes to show how difficult it really is to disrupt the big, well-established competition as a small ETF issuer.

Carter: I know it. Performance obviously helps. Being No. 1for the one-, three- and five-year periods is presumably helpful. Unfortunately, we achieved that right when the coronavirus showed up. But I’ll tell you, our performance year to date has been quite solid relative to the space. We’re net up creations, significantly, for the year. And we have more shares than we did when the coronavirus started. But prices went down.

One of the reasons I think this is a slam dunk version of the broader indexes is that most of these companies trade on the New York Stock Exchange or the Nasdaq. As you know, that’s why most of them were not included in the index, because they’re U.S.-listed.

Another thing that I would point out is that people often look at P/E multiples on the MSCI Emerging Markets Index to gauge if is it cheap or expensive. They’ll say, “Look how cheap it is. It’s selling for 11 times earnings, or 10 times earnings.” That’s a very low number, and a big discount to the S&P 500. That’s the biggest value trap in the world. The idea is that eventually, it’s got to come up, right?

But if you look at what's in the MSCI index, the Agricultural Bank of China shouldn’t have a P/E of that. It shouldn’t probably have a P/E of anything. But that’s what you're buying. If you look at the last decade, emerging markets broadly are down. I think they’ll be down again in the next eight years. The broad index is not really representative of where the growth is, which is the consumer story.

Contact Cinthia Murphy at [email protected]