the future of emerging markets - cfa institute · the future of emerging markets boca country club...

The Future of Emerging MarketsBoca Country Club

February 28, 2018

Alibaba HQ, Hangzhou, China

2

The Speakers

Dr. Burton G. MalkielDr. Malkiel serves as an Advisor to the EMQQ Index Committee. Dr. Malkiel is the

Chief Investment Officer of WealthFront and a long time Professor of Economics at

Princeton University. He is widely considered one of the pioneers of index investing

and ETFs. He has served as a member of the Board of Directors of Vanguard, Dean

of the Yale School of Management and as Chairman of the Princeton University

Economics Department. Dr. Malkiel is also well known for his seminal work A Random

Walk Down Wall Street. Dr. Malkiel holds B.A. and MBA degrees from Harvard and a

Ph.D. from Princeton University.

Kevin T. CarterMr. Carter is the Founder of Big Tree Capital an investment manager focused on

Emerging & Frontier Markets and of The Emerging Markets Internet ETF (NYSE:

EMQQ). Previously, Mr. Carter was the Founder & CEO of AlphaShares, an

investment firm offering five Emerging Markets ETFs in partnership with Guggenheim

Investments. Mr. Carter was also the Founder & CEO of Active Index Advisors

acquired by Natixis in 2005 and the Founder & CEO of eInvesting acquired by

ETRADE in 2000. Mr. Carter received a degree in Economics from the University of

Arizona in 1991 and began his career in 1992 with Robertson Stephens & Company.

The Case for Emerging Markets

Dr. Burton G. Malkiel

4

Figure 1 - Emerging Markets are 85% of the World

5.6x6,205,000,000

1,095,000,000

-

1,000,000,000

2,000,000,000

3,000,000,000

4,000,000,000

5,000,000,000

6,000,000,000

7,000,000,000

Emerging & Frontier Markets Developed Markets

World Population

5

Figure 2 - Emerging Markets are Passing Developed Markets

Source: IMF, World Economic Outlook database. April 2017

6

Figure 3 - Emerging Markets Will Dominate by 2050

Developed & Emerging Market GDPs 1950-2050

Source: Data from World Bank and The World in 2050, PricewaterhouseCoopers 2008

LINK TO

GAPMINDER

7

Figure 4 – IMF GDP Growth Forecasts

Region 2018 2019

Developed Countries 2.3 2.2

United States 2.7 2.5

Euro Area 2.2 2.0

Japan 1.2 0.9

Developing Countries 5.1 4.8

Brazil 1.9 2.1

Russia 1.7 1.5

India 7.4 7.8

China 6.6 6.4

World 3.9 3.9

8

Figure 5 - Demographics Favor Emerging Markets

Ratio of Working-Age to Non-Working Population

2010 - 2025

Developed Economies Emerging Economies

U.S. Germany Japan China Brazil India

2010 2.0 2.0 1.8 2.6 2.1 1.8

2015 1.9 1.9 1.5 2.7 2.2 1.9

2020 1.8 1.8 1.4 2.5 2.3 2.0

2025 1.7 1.6 1.4 2.4 2.2 2.1

9

Figure 6A – Economic Growth and Equity Returns

Be Wary of the Allure of High Economic Growth

10

Figure 6B - Economic Growth & Equity Returns: Be Wary

Source: World Bank, MSCI, Morningstar: Dimensional Fund Advisors, Economic Growth and Fund Returns.

August 2016

Annual GDP Growth vs Equity Market Excess Returns

11

Figure 7 - Valuation for Global Equity Indexes

Diverging

Again?

12

Figure 8 – U.S. Markets – Cyclically Adjusted P/E

16.4%

15.2%14.3%

11.8%11.1%

9.7% 9.5%

7.9%7.0%

3.7%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th

Median ten year annual compound total returns from historic P/E deciles 1926 to date

Ten years out

Stocks cheap Stocks expensiveDECILES

P/E Decile

P/E Range for

decile

1 Below 10.6x

2 10.6x to 11.6x

3 11.6x to 13.3x

4 13.3x to 15.1x

5 15.1x to 16.8x

6 16.8x to 18.2x

7 18.2x to 19.8x

8 19.8x to 21.6x

9 21.6x to 25.1x

10 25.1x and above

13

Figure 9 - Shiller PE Ratio of the S&P 500

1890 1990 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

45

40

35

30

25

20

15

10

5

0

Black Tuesday

Black Monday

33.04

As of 2/21/2018

14

Figure 10 – MSCI EM Shiller PE/CAPE

15

Figure 11 – MSCI China Shiller PE/CAPE

16

Figure 12 – 2017 Standard & Poor’s SPIVA Report

▪ Percentage of Active Funds outperformed by the S&P

Emerging Market Index

One Year to June 2017 75.4%

Three Years to June 2017 80.2%

Five Years to June 2017 75.3%

Ten Years to June 2017 87.9%

Fifteen Years to June 2017 95.2%

17

Figure 13 – Active EM Equity Funds vs. MSCI EM Index

Source: Morningstar & Vanguard Group

Worse than MSCI: 87% Better than MSCI: 13%

10 Years ending Dec 2013 (net for fees, including survivorship bias)

Problems with Traditional

Emerging Markets ETFs and

Indexes

Kevin T. Carter

19

What are Emerging Markets?

Emerging Americas Emerging Europe Emerging Africa Emerging Middle East Emerging Asia

Brazil Czech Republic South Africa Egypt China*

Chile Greece Kenya Qatar India

Columbia Hungary Mauritius United Arab Emirates Indonesia

Mexico Poland Morocco Bahrain Korea*

Peru Russia Nigeria Jordan Malaysia

Argentina Turkey Tunisia Kuwait Pakistan

Croatia Lebanon Philippines

Estonia Oman Taiwan

Lithuania Thailand

Kazakhstan Bangladesh

Romania Sri Lanka

Serbia Vietnam

Slovenia

Emerging Markets

Frontier Markets

Source: MSCI Classifications as of June 2017

*MSCI & FTSE

Disagree

20

#1 Problem: State Owned Enterprises (“SOEs”)

▪SOEs are companies owned and controlled by the

government in order to partake in commercial

activities on the government's behalf

▪State Owned Enterprises: – Conflicts of Interest

– Inefficient

– Poor Corporate Governance

– Widespread Corruption

▪ Largest Emerging Market ETFs have ~30% in SOEs- Does not include Korean Chaebol & Russian Oligarchs

21

#1 Problem – State Owned Enterprises (“SOEs”)

~30% of EEM & VWO are SOEs

22

SOEs: Chinese Economic Fugitives

Source: South China Morning Post.

23

Korean Chaebol

Source: The Wall Street Journal.

24

#2 Problem: Country Definitions and Weights

▪Weightings are Skewed – Towards Developed Countries (Korea & Taiwan)

– Towards Legacy industries

– Away from Entrepreneurial Growth Opportunities

25

GDP per capita

(current US$)

50,000

45,000

40,000

35,000

30,000

25,000

20,000

15,000

10,000

5,000

0

Stage 2: Transitional

Stage (Specialization,

surpluses, infrastructure)

Stage 1: Traditional

Society (subsistence,

barter, agriculture)

Stage 3: Take Off

(Industrialization, productivity

advances, growing investment)

Stage 4: Maturity

(diversification, innovation,

investment, consumption)

Stage 5: Mass Consumption

(Consumer goods flourish,

dominant service sector)

Chile Hungary

Poland

Czech Rep.

Turkey

Korea

1,000

millions

= 100

= 10

Taiwan

Morocco

United States

Argentina

= Developed

= Emerging

= Frontier

VietnamKenya

Croatia

Romania

Nigeria

Brazil

United

Kingdom

GermanyJapan

Malaysia

Hong Kong

Qatar

Singapore

Kazakhstan

UAE

Saudi Arabia

Denmark

Oman

Israel

Questions about EM Index Weights

Bangladesh

Kuwait

China

Mexico

IndiaEgypt

ColombiaPeru

S. Africa

Philippines

TunisiaThailand

Indonesia

Russia

Stage

1

Stage

2

Stage

3

Stage

4

Stage

5

26

Questions about EM Index Weights

1,267,300,000

51,202,130 23,374,000

-

200,000,000

400,000,000

600,000,000

800,000,000

1,000,000,000

1,200,000,000

1,400,000,000

India South Korea Taiwan

Population

54x25x

Source: World Bank.

27

Does This Make Sense?

7%

15%

13%

0%

2%

4%

6%

8%

10%

12%

14%

16%

India South Korea Taiwan

Weight in iShares Emerging Markets ETF (EEM)

Source: www.ishares.com.

28

GDP per capita

(current US$)

50,000

45,000

40,000

35,000

30,000

25,000

20,000

15,000

10,000

5,000

0

Stage 2: Transitional

Stage (Specialization,

surpluses, infrastructure)

Stage 1: Traditional

Society (subsistence,

barter, agriculture)

Stage 3: Take Off

(Industrialization, productivity

advances, growing investment)

Stage 4: Maturity

(diversification, innovation,

investment, consumption)

Stage 5: Mass Consumption

(Consumer goods flourish,

dominant service sector)

Chile Hungary

Poland

Czech Rep.

Turkey

Korea

1,000

millions

= 100

= 10

Taiwan

Morocco

United States

Argentina

= Developed

= Emerging

= Frontier

VietnamKenya

Croatia

Romania

Nigeria

Brazil

United

Kingdom

GermanyJapan

Malaysia

Hong Kong

Qatar

Singapore

Kazakhstan

UAE

Saudi Arabia

Denmark

Oman

Israel

Questions about Frontier Markets Index Weights

Bangladesh

Kuwait

China

Mexico

IndiaEgypt

ColombiaPeru

S. Africa

Philippines

TunisiaThailand

Indonesia

Russia

Stage

1

Stage

2

Stage

3

Stage

4

Stage

5

29

Frontier Market Weights (NYSE: FM)

17%

5%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Kuwait Nigeria

3.4x

Source: www.ishares.com.

30

Country Definitions & Weights are Messed Up

Source: World Bank.

3,268,431

183,523,000

-

20,000,000

40,000,000

60,000,000

80,000,000

100,000,000

120,000,000

140,000,000

160,000,000

180,000,000

200,000,000

Kuwait Nigeria

Population 60x

31

Kuwait – the 34th largest city in China

City Population Shanghai 22,315,474

Beijing 11,716,620

Tianjin 11,090,314

Guangzhou 11,071,424

Shenzhen 10,358,381

Wuhan 9,785,388

Dongguan 8,000,000

Chongqing 7,457,600

Chengdu 7,415,590

Nanjing 7,165,292

Nanchong 7,150,000

Xi’an 6,501,190

Shenyang 6,255,921

Hangzhou 6,241,971

Harbin 5,878,939

Tai’an 5,499,000

Suzhou 5,345,961

Shantou 5,329,024

Jinan 4,335,989

Zhengzhou 4,253,913

Changchun 4,193,073

Dalian 4,087,733

Kunming 3,855,346

Qingdao 3,718,835

Foshan 3,600,000

Puyang 3,590,000

Wuxi 3,543,719

Xiamen 3,531,347

Tianshui 3,500,000

Ningbo 3,491,597

Shiyan 3,460,000

Taiyuan 3,426,519

Tangshan 3,372,102

KUWAIT 3,369,000

Hefei 3,310,268

Zibo 3,129,228

Zhongshan 3,121,275

Changsha 3,093,980

Ürümqi 3,029,372

Something Big is Happening in

Emerging Markets:

The Great Confluence

33

The Growth of EM Consumption is a VERY Big Deal

“The biggest growth opportunity in the history of capitalism”

- McKinsey & Company

34

Smartphones Are Still a New Thing

35

Smartphones Changing Our Consumption Patterns

OLD WAY

36

Smartphones Changing Our Consumption Patterns

NEW WAY

37

+ New Entrants Offering Low Cost Smart Phones

38

= Smartphones Sweeping Across World

39

+ Growth of Affordable Access to Broadband

40

+ U.S. VC funding EM Entrepreneurs

41

$14.9 $21.1

$31.3

$43.6

$63.9

$89.9

$120.6

$162.8

$-

$20.0

$40.0

$60.0

$80.0

$100.0

$120.0

$140.0

$160.0

$180.0

2009 2010 2011 2012 2013 2014 2015 2016

EMQQ Index Revenue & Growth Rate*

2009-2016($USD Billions) +35.0%

+41.1%+48.5%

+39.2%

+46.6%

+40.7%

+34.2%

Result #1= Massive Revenue Growth (CAGR 40.7%)

Source: Big Tree Capital LLC Estimates

42

Result #2 = Value Creation

Source: Solactive, AG

625.06

153.11

0

100

200

300

400

500

600

700

EMQQ Index vs MSCI EEMAs of 1/31/2018

EMQQ

EEM

43

= Largest IPO in U.S. History

Source: Wall Street Journal.

44

Alibaba IPO’s Huge ETF

Conundrum“…many questions have been raised regarding how the newly public company will be placed in ETFs.”

- ETF.com

One More thing – BABA was NOT in the index

One place you won't get Alibaba: The big ETFs“Alibaba's blockbuster debut as a publicly traded stock has been everywhere. One place it won't be, though, is in a lot of investor portfolios…..The fact that they're saying it won't be in many indices, or broadly followed indices, it raises the question of what indices are supposed to do.” - USA Today

Alibaba doesn’t fit into the indexing framework at FTSE and MSCI so “it kind of just gets lost.”

- Morningstar

Didn't buy into the Alibaba IPO?

You may own it anyway…“…So how about an ETF that tracks Chinese firms? Not so fast: The major indexes for Chinese shares don't consider Alibaba a Chinese company (Alibaba is incorporated in the Cayman Islands), so you won't find Alibaba in those funds either.”

– Consumer Reports

“…why even have these indexes?”- CNBC.com

“It’s the clash of the old world legacy

index companies with the fast pace of

IPOs and ETFs today” - Tom Lydon

45

Where is Alibaba (NYSE: BABA)?*

VWO (Vanguard Emerging Markets ETF)

FTSE Emerging Markets Index

Company %

1 Tencent Holdings Ltd. 3.51%

2 Taiwan Semiconductor Manufacturing Co. 2.12%

3 Naspers Ltd. 1.67%

4 China Construction Bank Corp. 1.64%

5 Taiwan Semiconductor Manufacturing Co. ADR 1.34%

5 China Mobile Ltd. 1.31%

6 Industrial & Commercial Bank of China Ltd. 1.08%

7 Hon Hai Precision Industry Co. Ltd. 1.02%

9 Bank of China Ltd. 0.86%

10 Housing Development Finance Corp. Ltd. 0.83%

Source: Vanguard.

VWO was missing most of the Great Confluence

46

Social Networks - Tencent (HK: 0700)

U.S. China

47

A Lost Decade? (Tencent vs. SP 500 vs. MSCI EM)

Source: BigCharts.

48

WUBA - 58.com “The Craigslist of China”

49

MELI – “The Amazon/PayPal of Latin America”

50

YNDX – “The Google & Uber of Russia”

51

MMYT – “The Expedia of India”

52

Private Companies inside of Public Companies

53

Go-Jek – “The Uber of Indonesia”

54

Flipkart – “the Alibaba of India”

55

“The Steve Jobs of Africa” – Konga CEO Sim Shagaya

56

The Case for the Emerging Markets Internet Sector

▪ Growth - The Great Confluence

‒ EM Consumer + Smartphones + Internet via Mobile Broadband

‒ Ecommerce models “leapfrogging” traditional models

‒ Ecommerce growing 5x as fast as consumption

▪ Better Corporate Governance

‒ No State Owned Enterprises

‒ Most companies backed by U.S. VC & trade on U.S. exchanges

▪ Exposure to Private Companies & Frontier Markets

57

The Future Of Emerging Markets is Here

Q&A