Analyse: CS ETF (Lux) on MSCI Emerging Markets

As economic growth in the developed world has slowed down amidst consumer and government deleveraging, much of the developing world has continued to exhibit strong growth. As the group’s largest economy, and the biggest weighting in the index, China will have a considerable impact on the fortunes of the MSCI Emerging Markets Index. After a couple of years of monetary tightening, the People’s Bank of China in the summer of 2012 began cutting interest rates. The back-and-forth in policy signalling highlights the delicate juncture of the country’s economy. China’s GDP grew by 7.4% in the 12 months through the third quarter of 2012; robust on an absolute basis but less than had become customary. With many parts of the developed world falling back into recession, the demand for Chinese exports has begun to dry up. As the beleaguered developed-world consumer continues to pare back, China will have to rely more and more on domestic demand from its own burgeoning middle class. Politically, China is in flux. In November the ruling Communist Party appointed Xi Jinping as its new leader, in a once-every-decade transfer of power. At the same time, the country has found itself caught up in disputes with Japan over control of some uninhabited islands. This could have a meaningful impact on trade; Japan is the largest source of imports for China. The economy of South Korea has grown dramatically in the past few decades. According to The Economist, it now boasts a GDP per head that is higher than the European Union average. Although still classified as an emerging market by MSCI, many now consider South Korea a developed country. Much of the private sector growth has been driven by a system of very large conglomerates–such as Samsung, LG, and Hyundai– but corporate governance concerns have dogged them as a result of their family-run structure. South Korea’s fortunes depend heavily on China, which is the largest market for its exports. Taiwan is also dependent on China as a trading partner. Its export-driven economy has expanded considerably in the last few decades. Recent growth, however, has not been as robust as some of its neighbours. Its GDP grew by just 1.0% in the twelve months through the end of the third quarter. Brazil’s wealth of natural resources has made it a substantial beneficiary of the past decade’s trend towards higher commodity prices. A big part of that trend has been the rapid growth of materials-hungry China, as well as Malthusian concerns about the world running out of non-renewable resources. The concern right now is that with China slowing down and other parts of the world in recession, the demand for raw materials could fall considerably. Further muddying the picture is the rapid pace of new natural gas discoveries in the United States. Indeed, Brazil’s growth has slowed considerably. For the 12 months through the third quarter of 2012, its GDP grew just 0.9%. Over the last 10 years, the MSCI Emerging Markets Index has produced an annual return of 14.90%, versus 6.09% for the MSCI World Index, which covers only developed market equities. Its price-to-earnings ratio was 9.9 at the end of December, up from its low of 7.1 in May 2009, but still below its five year average level of 11.6.

Indexkonstruktion

The MSCI Emerging Markets Index is a free float market capitalisation-weighted index covering 21 emerging market countries from all over the world. It currently has 821 large- and mid-cap constituents and covers approximately 85% of the free float-adjusted market capitalisation of the component countries. The index is reviewed quarterly, with size cut-offs recalculated semi-annually. The universe is initially screened for liquidity, as measured by the value and frequency of trading. The median constituent has a market capitalisation of $2.3 billion. At the end of December 2012, the top geographic exposures were China, South Korea, and Brazil, with respective weights of 18.3%, 15.3%, and 12.6%, followed by Taiwan at 10.6% and South Africa at 7.8%. On a sector basis the index is broadly diversified. The top weight is Financials, making up 26.5% of the total, followed by Information Technology at 13.8%, Energy at 12.5%, Materials at 11.8%, and Consumer Staples at 8.8%. The index is not very concentrated, with just 16.2% in the top 10 names. The top position is Samsung Electronics Co., at a 4.06% weight.

Fondskonstruktion

The fund currently uses optimised sampling to try to capture the performance of its benchmark, holding a physical basket of securities designed to match the characteristics of the underlying index but not the exact stocks in the exact weights. Compared to the index’s 821 constituents, the fund held 375 at the end of December 2012. The fund is domiciled in Luxembourg and uses the U.S. dollar as its base currency. The fund’s prospectus gives Credit Suisse the flexibility to change the fund’s replication method, to full physical or synthetic, or any combination of the three, according to its discretion. In the case that the fund used swaps for synthetic replication, the counterparty would normally be a member of the Credit Suisse group. Swaps could be funded or unfunded, with the substitute basket or collateral held by the fund’s custodian and marked to market on a daily basis. Dividends paid to the fund by its underlying holdings are immediately reinvested, rather than being distributed to the fund’s investors. This should reduce the cash drag that can result from accumulating dividends. The fund does engage in securities lending. According to Credit Suisse, the loans are collateralised to at least 100% of their value every day, and usually to a level of 102% to 105%. In the twelve months through the end of September 2012, an average of 2.8% of the portfolio was out on loan, to a maximum of 5.2%, and in total the activity added 2.2 basis points to the fund’s net return.

Gebühren

The fund has a total expense ratio (TER) of 0.67%, which is middling in relation to other funds that provide similar exposure. Other costs potentially borne by the unitholder but not included in the total expense ratio include bid-ask spreads on the ETF, securities lending fees, transaction costs on the infrequent occasions when the underlying holdings change, and brokerage fees when buy and sell orders are placed for ETF shares. Income generated from securities lending could potentially recoup some of the total costs.

Alternativen

Many providers offer ETFs tracking the MSCI Emerging Markets Index, including UBS, Amundi, SPDR, ComStage, Lyxor, db x-trackers, iShares, Source, ETFlab, and HSBC. Vanguard FTSE Emerging Markets ETF follows a different benchmark but provides a similar exposure. For alternatives to market capitalisation-weighted exposures, there are Ossiam ETF Emerging Markets Minimum Variance and PowerShares FTSE RAFI Emerging Markets ETF. Of all of these, the largest are the iShares and the db x-trackers funds, with assets of $7.5 billion and $3.9 billion respectively. The funds with the lowest TER are the Amundi product, the Vanguard product, and the Source product, each with a TER of 0.45%.