The MSCI Emerging Markets Index is a free-float-adjusted, market-cap-weighted index covering large- and mid-cap companies in 24 emerging markets. With more than 800 constituents, the index covers approximately 85% of the readily available shares in each representative country. The index is reviewed quarterly and rebalanced semiannually. Components must meet minimum criteria for liquidity, minimum free-float-adjusted market capitalisation, and foreign ownership, as well as a waiting period for newly listed stocks.
As of 1 Dec 2015, MSCI included foreign-listed companies, otherwise known as N-shares, into their global indexes, including the MSCI Emerging Markets Index. Upon inclusion, China's index representation increased by more than 2%. Internet behemoths Alibaba, Baidu, and JD.com were added as constituents.
In June 2017, MSCI decided to add China A-shares into its global equity indexes, including the MSCI Emerging Markets Index. The partial addition of A-shares was initiated in May 2018 and will gradually increase. Assuming the full addition of China A-shares, China’s weight in the MSCI Emerging Markets Index will hover around 40%.
Current top geographic exposures are China (30%-35%), South Korea, and Taiwan (each 10%-15%). On a sector basis, the index is tilted toward information technology and financials (20%-25% each). The index is not very concentrated at the stock level, with typically 20%-25% in the top 10 names.
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The ETF's ongoing charge of 0.55% is higher than that of other ETFs offering similar exposure.
The annualised tracking difference (fund return less index return) during the past three years has been negative 0.72% for the period ended February 2019, indicating that the total cost of holding this fund has been higher than the ongoing charge.
Additional costs to investors associated with trading the ETF include bid-ask spreads and brokerage fees.
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The Lyxor MSCI Emerging Markets UCITS ETF uses synthetic replication to capture the returns of the MSCI Emerging Markets Net Return Index. Instead of investing directly in the components of the index, the ETF enters into a swap agreement with counterparty and parent bank Societe Generale. In this transaction, the ETF uses investors' cash to buy a substitute basket of securities and exchanges their return for the return of the MSCI Emerging Markets Index.
While Lyxor uses Societe General as the sole direct swap counterparty, the firm commits to targeting zero counterparty risk exposure. The swap is therefore reset whenever the swap value becomes positive. Swaps may sometimes have a negative value, which would be equivalent to an overcollateralisation of the fund. The substitute basket, which can change daily, consists of stocks with a minimum average trading volume and market cap, including stocks from indexes such as the MSCI Developed World, MSCI Emerging Market World, MSCI Developed World Small Cap, Stoxx Europe 600, and FTSE 250 indexes.
The fund's holdings are monitored daily by Lyxor's asset manager and held in a segregated account at Lyxor's custodian, Societe Generale Security Services.
Lyxor's ETF fund management practices are within passive industry norm, and we value its strong commitment to the delivery of tight tracking for its mixed range of swap-based and physical ETFs.
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We have no conviction that Lyxor MSCI Emerging Markets ETF will outperform its peers over the long term; hence, we maintain its Morningstar Analyst Rating of Neutral.
This exchange-traded fund has an ongoing charge of 0.55%. It is cheaper than actively managed peers in the global emerging-markets equity Morningstar Category. However, it is notably higher than passive peers that offer the same or similar exposure. The passive funds’ average ongoing charge in the category falls at 45 basis points.
The MSCI Emerging Markets Index entails some country concentration risk. While the index counts in 24 emerging-markets countries, the majority of the portfolio falls in three countries that comprise more than half of the fund: China (30%), South Korea (14%), and Taiwan (11%). Since 2017, MSCI has implemented phased inclusion of China A-shares into its global and emerging-markets indexes. Assuming the full inclusion of A-shares, China’s weighting in the MSCI Emerging Markets Index can hover around 40%.
While such seemingly country bets may be concerning, investors should bear in mind that the underlying countries that form emerging markets are constantly changing in order to reflect the economic and financial market developments of these countries. By holding an index fund that is representative of the broad asset class, investors can ride on the general market developments that is incorporated in the evolution of the index.
In terms of performance, the fund's three- and five-year risk/reward profiles have been average relative to category peers. However, over 10 years, the fund falls below the average, which is partially attributable to its higher fees. Lyxor's strong commitment to tracking efficiency has managed tight tracking error, which has remained at 0.2 basis points.
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Thanks to the dramatic changes in economic fundamentals as well as financial market development in emerging markets, the list of countries that constitutes emerging markets has evolved over time. Looking at the MSCI All Country World Index, which includes both developed and emerging markets, emerging markets represented a mere 1% of the index in 1988 with 10 countries. The figure rose to 11% with 24 countries by end-2018. The pace of such developments has further accelerated in recent years.
From its inception in January 2001 to the end of February 2019, the MSCI Emerging Markets Index’s annualised return amounted to 9.08%, versus 4.97% for the MSCI World Index (developed markets) and 5.10% for the MSCI All Country World Index (developed and emerging markets).
The MSCI Emerging Markets Index has also changed materially over the past few years. In terms of country membership, the most significant changes have been the decline in Brazil (from a peak of 15.9% in September 2010 to 7.6% as of February 2019) and the increase in China (up to 32.1% from 18% during the same period). These divergent paths among countries show that each country has different economic or financial market drivers, such as natural resources for Brazil, technology for China, as well as various currency impacts. In December 2010, the energy and materials sector represented a combined 29%, and this declined to 15% by the end of 2018. On the contrary, tech sector shares increased to 27% from 12% during the same period.
China’s weighting in the MSCI Emerging Markets Index is likely to continue increasing. In June 2017, MSCI announced that it would include China A-shares in the MSCI Emerging Markets and MSCI ACWI indexes. This is in recognition of the significant strides China has made toward opening its capital markets to foreign investors. As long as China’s economy continues growing and its impact on global capital market increases, its weightings in emerging as well as global equity markets will increase.
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Several providers offer MSCI Emerging Markets Index ETFs including iShares, Xtrackers, Amundi, and Lyxor. Ongoing charges range between 0.18% and 0.75%. The synthetically replicated accumulating Amundi MSCI Emerging Markets ETF with an ongoing charge of 0.20% is a direct alternative to this fund. It is one of the cheapest and best-performing ETFs tracking the MSCI Emerging Markets Index.
Those seeking more-diversified and local emerging-markets exposure can look to iShares Core MSCI Emerging Markets IMI ETF (ongoing charge of 0.18%). Unlike the more widely used MSCI Emerging Markets Index, the MSCI Emerging Markets IMI includes small-cap stocks, representing about 5% of the index value.
As for physically replicated alternatives, investors can look to Vanguard Emerging Markets Stock Index GBP Acc, which comes at an ongoing charge of 0.27%. This ETF tracks the same benchmark employing full replication methodology.
In the strategic-beta department, investors may consider iShares MSCI Emerging Markets Minimum Volatility ETF (ongoing charge 0.40%) or Lyxor FTSE Emerging Minimum Variance ETF (ongoing charge 0.40%). Both indexes are designed to minimise volatility.
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