Emerging markets ready to run in 2021

Companies like Taiwan Semiconductor are an important part of the emerging markets index.

Where to invest next year? I believe emerging markets (EM) will be an outperforming asset class in 2021.

 EM is a misrepresented term. It is not only dominated by four large Asian markets that make up 76 per cent of the index but also by a very few largely China-based companies. In other words, it is an Asian index with a few other markets thrown in.

Ironically, this means emerging markets have a lot more in common with Wall Street than many might realise.

 Swollen by the tech boom, the US represents now represents an unprecedented 58.13 per cent of the MSCI All Countries World Index.

Based on the October 30 numbers of the Morgan Stanley Capital International (MSCI US), IT represented a massive 28.1 per cent and communications 11.1 per cent of that index.

 In fact, the top five stocks represent almost a quarter — or 21.42 per cent — of the MSCI US index: Apple (6.46 per cent), Microsoft (5.01 per cent), Amazon (4.42 per cent) Alphabet A and C (3.34 per cent) and Facebook (2.17 per cent).

 The same pattern is evident in emerging markets, where the top 10 stocks account for a third of the index.

Most recently, the three largest stocks, Alibaba (China), Tencent (China) and Taiwan Semiconductor contributed more than 13 per cent to annual returns while the overall index was up 5.9 per cent.

Who would have thought at the end of March 2020, big tech could power world markets to rebound so much?

Who guessed the Nasdaq would be up more than 42 per cent to the end of November, the S&P 500 up over 17 per cent and China up over 20 per cent on a rolling 12-month basis?

Now the positive vaccine news has seen a shift of leadership in equity markets away from the large growth and tech stocks towards those countries, regions, sectors and stocks that have been severely impacted by the pandemic and are likely to benefit most from economic recovery.

It’s looking like a rotation that will be very beneficial to emerging markets — even if they are dominated by a handful of companies.

The extent to which this rotation is merely a shorter-term cyclical adjustment, or a more sustained trend, partly depends on the direction and magnitude of any movement in bond yields.

The message from all of this is that as positive as I am about EM and emerging Asia for 2021 it is vital to know that you are dealing in a concentrated index. It is reliant on four markets and perhaps 10 stocks that will have an enormous influence on the performance of that index.

This makes a compelling case for a conviction approach to this asset class as you look at how to position yourself for exposure.

Will Hamilton is the managing partner of Hamilton Wealth Partners, a Melbourne-based wealth manager.