WisdomTree Creates an Emerging Markets ex-State-Owned Enterprises Index by Jeremy Schwartz, Director of Research and Tripp Zimmerman, Research Analyst, The WisdomTree Blog

In a previous blog post we discussed the characteristics of emerging market state-owned enterprises and the growing interest that some investors have expressed in avoiding or limiting their exposures. State-owned enterprises are typically defined as companies that are either wholly or partially owned or operated by a government. Some investors believe that government ownership can negatively impact the operational aspects of a company because government-owned companies might be influenced by a broader set of interests, beyond generating profits for shareholders.

The Economist magazine ran an article that sums up the bottom-line concern for investors: “The performance of state-owned enterprises has been shockingly bad.”1 In the words of the Economist article:

Ronald Reagan said the nine most terrifying words in the English language were “I’m from the government and I’m here to help.” For investors the scariest words may be, “I’m from a state-owned firm and I want your capital.” Across the world, big, listed state-owned enterprises (SOEs) that were floated, or raised mountains of equity, between 2000 and 2010 have had a dismal time. Their share of global market capitalization has shrunk from a peak of 22% in 2007 to 13% today.

To be fair, there are certainly price levels at which these state-owned companies can become very cheap, and all the bad news can become reflected in the prices such that they perform very well going forward. But given the dominance of many emerging market indexes in state-run companies (as much as 25% to 30% of popular benchmarks), WisdomTree thought it prudent to offer an alternative view of the emerging markets—without state-run companies.

Therefore, we introduce our new Index, the WisdomTree Emerging Markets ex-State-Owned Enterprises (EMXSOE), which is designed to measure the performance of broad-based emerging market stocks that exclude state-owned companies. To WisdomTree, state-owned enterprises are defined as those having government ownership of more than 20% of outstanding shares.

Index Methodology

The Index employs a modified float-adjusted market-capitalization weighting process to target the weights of countries in the universe prior to the removal of state-owned enterprises while also limiting sector deviations to 3% of the starting universe float-adjusted market. The application of this rule is intended to provide a type of beta exposure that targets the initial universe from a country perspective, once the state-owned companies have been removed.

Eligible Universes: Must be incorporated or domiciled and have their shares listed on exchanges in one of the following countries: Brazil, Chile, China, Czech Republic, Hungary, India, Indonesia, Malaysia, Mexico, Peru, Philippines, Poland, Russia, South Africa, South Korea, Taiwan, Thailand or Turkey2

State-Owned Enterprises: Companies with more than 20% ownership by government body are excluded

Minimum Market Capitalization: $1.0 billion

Weighting: Modified float-adjusted market capitalization

Holding Caps and Weight Adjustments

Country Weights: Target weight equal to float-adjusted market caps of universe prior to removal of SOEs3

Sector Weights: Constrain differentials to 3% differentials from starting universe, after country adjustment

WisdomTree Emerging Markets ex-State-Owned Enterprises Index: Top 20 Index Holdings

Emerging Markets

For definitions of terms in the chart, please visit our glossary.

Information Technology Rises to the Top: Given emerging market governments’ low involvement in the Information Technology sector, we are not surprised that the weights of some of the largest companies increase after the state-owned enterprises have been removed. Although the sector is well-represented among the top five holdings, the Index caps sector differentials to 3%, compared to the starting universe, at each annual rebalance, in an effort to remain diversified and not take large sector risks.

As emerging market countries continue to grow and transform, investors will demand more ways to gain access to this unique asset class. Recently, some investors have expressed concern over state-owned enterprises, and they have sought tools to limit their exposure, even after understanding the valuation differences. These investors are interested in concentrating their exposure on the private sector and accessing higher growth potential. Although it is impossible to know which area will be more beneficial to focus on going forward, we think it is important to have different tools available, and the case for either exposure could be made, depending on an investor’s goals and objectives.

For full research on the Emerging Markets ex-State-Owned Enterprises Index click here.

1Source: The Economist, 11/22/14.
2Companies domiciled or incorporated in those countries but trading primarily on a U.S. stock exchange are also eligible for inclusion.
3The maximum country factor is set at 3.0, or no country’s weight can be increased more than 3x after state-owned enterprises have been removed.

Important Risks Related to this Article

Investments in emerging, offshore or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments.

Click here to obtain a WisdomTree ETF prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

There are risks involved with investing, including possible loss of principal. Foreign investing involves currency, political and economic risk. Funds focusing on a single country, sector and/or funds that emphasize investments in smaller companies may experience greater price volatility. Investments in emerging markets, currency, fixed income and alternative investments include additional risks. Please see prospectus for discussion of risks.

Past performance is not indicative of future results. This material contains the opinions of the author, which are subject to change, and should not to be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. There is no guarantee that any strategies discussed will work under all market conditions. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein. Neither WisdomTree nor its affiliates, nor ALPS Distributors, Inc., or its affiliates provide tax or legal advice. Investors seeking tax or legal advice should consult their tax or legal advisor. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.

Jonathan Steinberg, Luciano Siracusano III, Jeremy Schwartz, David Abner, Rick Harper, Sean Kelly, Christopher Gannatti, Bradley Krom, Tripp Zimmerman, Eswarie Subrahmanyam S. Balan, Zachary Hascoe, and Anita Rausch are registered representatives of ALPS Distributors, Inc.

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