Emerging market equities have been sliding most of this year because investors have wanted to take advantage of recovering developed market equities and avoid the unintended side effects of tapering as much as possible. Anytime there’s a mass exodus from one type of asset, value investors should take a second look to see if there are quality stocks being seriously undervalued, but they might not have to invest in emerging market stocks to gain EM exposure.
A few years back, Citi developed a basket of DM companies with an average 60% revenue exposure to emerging market economies. Commodities like oil and metals were excluded, since those industries necessarily have emerging market exposure regardless of where they’re headquartered, and the rest of the basket ended up being composed mostly of food and beverage, semiconductor, and tech companies. The companies are based mostly in Europe (52%) followed by North America (35%) and Japan (13%).
Emerging market in DM basket has tracked DM stocks
The emerging market in DM basket has mostly tracked the DM index in 2013 and 2014, diverging from EM MSCI around the end of 2012.
“The EM in DM basket was a good way to play EM economies in 2013: the EM in DM basket was up 23%, only slightly behind the MSCI DM World index (+24%). By contrast, the DM Materials sector (+1%) and Energy (+15%) underperformed significantly,” write Citi’s global strategy team made up of Robert Buckland, Mert Genc, Beata M Manthey, and Jonathon Stubbs. “As for 2014, it is more of the same. The emerging market in DM basket is slightly underperforming the MSCI DM index (-2% vs -1%), but still outperforming EM equities (-5%).”
Using the emerging market in DM basket as a screen
This might not sound compelling, after all it did underperform the DM indexes all last year, but the emerging market in DM basket could be a great screener for stock selection strategies.
“The median stock in our basket is up only 16% since the start of 2013, so a meaningful underperformer. But, overall, the outperformers have been so strong that they have dragged the whole basket (calculated on an average basis) up towards the DM index,” says the Citi report.
In other words, the average tracked DM indexes not because the typical country’s performance, but because the outperformers did extremely well. Even if you’re not interested in investing in the basket as an index, it could be a promising place to start looking for undervalued emerging market exposure.