Three Common Pitfalls for Targeting Emerging Market Consumers

Over recent years, allocations to emerging markets were rare. Yet many investors would agree that the growth of the emerging market consumer class, with its huge population advantage over the developed world, could be one of the single most important factors for global economic growth going forward. We recently read an interesting thought piece on the Future for Asia, which compiled 100 statistics on Asia. We pulled out five that we thought were particularly interesting but would recommend the full piece¹:   Common Pitfalls of Emerging Market Investments These statistics buttress the notion that 1) the scale of the numbers is very large, and 2) the growth rates, as people go from not having things like electricity or a car to having them, are quite high. But these things alone do not lead to strong investment returns, in our view.   Pitfall 1: Excitement Leads to Expensive Markets It is fun to be excited and to be in awe of some of these statistics, but “awe” tends to be a negative for investments. Things like “awe” and “excitement” push up valuations, making it hard to generate compelling future returns.   Pitfall 2: Many Large Emerging Market Companies Have Little to Do with Emerging Market Consumers Some of the largest companies in emerging markets are banks and companies in the Energy and Materials sectors. In many cases, they are owned by governments, and they typically tend to react to global macroeconomic conditions rather than changes in the actual emerging market consumers.   Pitfall 3: Thematic Investments Can Be Very Narrow In focusing on consumption, the first, natural stop is in the Consumer Staples and Consumer Discretionary sectors. But what about smaller private-sector banks? Health care firms? Technology firms? The interests and needs of growing emerging market consumers are likely to be wide-ranging, requiring a similarly wide-ranging focus among investors.   WisdomTree’s Innovation in Emerging Market Consumer Growth The WisdomTree Emerging Markets Consumer Growth Index directly combats these three potential pitfalls at each annual Index screening:   Solution 1: Valuation, specifically the earnings yield, is a component of the selection methodology. Lower earnings yields (in other words, higher price-to-earnings (P/E) ratios) make it harder for stocks to gain inclusion.   Solution 2: Banks greater than $10 billion in market capitalization and Energy and Materials firms are not eligible.   Solution 3: Eight sectors are eligible for inclusion, and 250 constituents are included.   Consumer Growth Performance without the Premium P/E Ratio • Over the periods shown, the WisdomTree Emerging Markets Consumer Growth Index performed similarly to the Dow Jones Emerging Markets Consumer Titans 30 Index. Both Indexes also outperformed the MSCI Emerging Markets Index over the YTD and 1-year periods. • What we find more remarkable, however, is that the WisdomTree Index delivered this performance and retained a P/E ratio very similar to broader emerging markets. The Dow Jones index, on the other hand, had a P/E ratio almost twice that of broader emerging markets. Remember, a high valuation today makes for a higher hurdle for future returns.   As investors become more open to emerging market allocations, we think the future of the global economy is undoubtedly powered by the emerging market consumer, and WisdomTree has developed a solution to address the common pitfalls of accessing this emerging market consumer theme.         ¹Source:“Future of Asia by the Numbers: 100 Facts,” compiled by Gurcharan Gill & Emily Kim, 8/16.