Emerging Markets and State-Owned Enterprises

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

When investors allocate to emerging markets, they typically do so through broad-based market cap-weighted exposure. More recently, investors have shown interest in specific cuts or subsets of the broader emerging markets, such as country rotation, high-dividend-yield strategies, small caps, low volatility and other investment strategies.

We’ve seen growing interest in the degree of exposure to state-owned enterprises (SOE) in various investment strategies. 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.

Characteristics of State-Owned Enterprises

State ownership levels can vary significantly among sectors and countries, depending both on a sector’s significance for providing public goods or fostering economic growth and on the governmental structure. WisdomTree identified 424 companies out of an initial 3,000 companies in emerging markets as state-owned enterprises (SOE), with government owning more than 20% of shares. The SOEs had market cap of over $1.31 trillion, about 26% of the original universe’s market cap of approximately $5.07 trillion.1 Figures 1 and 2 illustrate the market cap profiles of the SOE universe by sectors and countries.

Figure 1: State-Owned Enterprises by Sector

Emerging Markets

  • Ownership Concentrated among Public Good Sectors: Given that the Financials, Energy, Telecom and Utilities sectors are among the most systemically important sectors to economic development, we are not surprised that governments tend to play a more active role in these sectors.• Less Ownership among Private Good Sectors: Currently, governments are less involved in the Consumer Discretionary and Consumer Staples, Information Technology and Health Care sectors. Companies in many consumer-focused sectors tend to be less vital to the strategic economic development and welfare of emerging market governments. These sectors also are often the focus for growth investors who see a burgeoning opportunity as emerging market consumers develop and increase their income and standard of living.

Figure 2: State-Owned Enterprises by Country

Emerging Markets

  • China Displayed the Largest Government Involvement: Given China’s communist background, it is not surprising that almost half of the SOE market cap companies are Chinese companies. A large percentage of the Chinese government’s market cap ownership comes from the stakes it holds in the country’s large financial institutions. These large state-owned banks are among the lowest-priced areas of the entire emerging markets, with average dividend yields over 6% and price-to-earnings (P/E) ratios below 5x.2Russia Also Displayed Significant Government Involvement: Russia’s socialist and communist history has led to noteworthy government ownership in the Energy and Financials sectors. Although the recent Ukrainian conflicts have further depressed valuations, the Russian Energy sector had already displayed depressed valuations compared to the broader emerging markets before the crisis. For example, Gazprom and Rosneft, two of the largest state-owned energy companies, have dividend yields north of 5% and P/E ratios under 5x.3

WisdomTree created a broad-based Index to emerging market stocks that are not state-owned enterprises; this Index will help investors monitor the performance of this subset. In a future blog post, we will introduce this new Index, the WisdomTree Emerging Markets Ex State Owned Enterprises (EMXSOE), designed to measure the performance of broad-based emerging market stocks that exclude state-owned companies.

1Sources: WisdomTree, Standard and Poor’s, as of 7/31/14.
2Sources: WisdomTree, Bloomberg; refers to the five largest dividend-paying Chinese banks as of 9/30/14.
3Sources: WisdomTree, Bloomberg, as of 9/30/14. The WisdomTree Emerging Markets Ex State Owned Enterprises Index does not hold Gazprom or Rosneft.

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.

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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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