EuroBusinessMedia (EBM): Today, we are talking about using ETFs to invest in emerging markets. iShares has just published its new Emerging Markets Equity Index Guide and we are speaking today with Nizam Hamid. Welcome. You are the Head of Sales Strategy for iShares in Europe. Why did you decide that now was the right time to publish an Emerging Markets Equity Index Guide?
Nizam Hamid (NH): We’ve seen a lot of interest from investors in emerging markets and it’s certainly been one of the main themes over the past year. You can see that in the trends for the market as a whole when it comes to ETFs, with emerging market ETF flows outstripping developed market flows since about the middle of last year. And what has become very apparent to us, is that it is very important for those investors to really understand what’s behind the emerging market ETFs. To understand that, you need to know what’s behind the indices and really where your risk lies in individual countries.
EBM: In a few words, what are the main highlights of this guide?
NH: The main highlights of this guide would be to look at all the liquid indices which really form the basis for the majority of ETFs and really help people understand how that matches the main benchmarks that they might use. That might be an MSCI benchmark, a FTSE benchmark. On the other hand, they might be using slightly different versions of the indices, so a FTSE/Xinhua Index to cover China for example or a Stoxx EU Index to cover Eastern Europe or BRIC Index. It’s just very important for people to understand the risk, the country selection, the liquidity selection and foreign ownership issues.
EBM: Are there some specific things to be aware of before investing in emerging market ETFs? For example, your guide spends a lot of time discussing country classification, namely the distinction between ‘emerging’ and ‘frontier’ countries for example, or liquidity and risk issues surrounding these markets…
NH: Yes, you have three main classifications of countries. Developed markets we’re all very familiar with, emerging markets and then frontier markets. But different index providers treat different countries in a different way and you might need to know, for example, whether a country like Korea is a developed market or an emerging market, depending on whose index you use. So FTSE, for example, have Korea as a developed market now, for MSCI it’s still only an emerging market. And these classifications also change significantly over time, so what might have been an emerging market two years ago may already have moved. So from an end investor perspective, it’s really important to keep track of those types of developments.
EBM: Since country classification can make such a huge difference on investor interest in different emerging countries, what are the countries to watch for in 2010, meaning those countries which are likely to be re-classified this year?
NH: Difficult to say exactly what’s going to be reclassified, but on the watch list you’ve got important countries, like Korea and Taiwan, which are a very large portion of the emerging market index. Potentially they could become developed markets. You’ve got Qatar and UAE, which are currently emerging, sort of frontier market, could become an emerging market. Again, there is an issue there for an investor understanding the extra risk you would have for those type of countries were they to transition from frontier to emerging market, so it’s very important to probably keep those in the forefront of people’s minds.
EBM: And what about countries which are in no index today, for example, but which tomorrow could become part of a frontier index?
NH: Again yes, there are lots of countries that are not necessarily classified at all. And they might come into the frontier classification or they might actually move out as well. I mean, you have countries where you have problems with liquidity. They could actually move outside of any classification. So again, people need to be aware of that. As ETF providers, we are also aware of that, because it’s clearly important to us to manage the risk and the liquidity in the ETFs that we provide.
EBM: Your guide makes a specific focus on BRIC and Eastern Europe indices, what’s important to know here?
NH: I think that BRIC - Brazil, Russia, India and China - has been a very trendy, very popular area for many investors over the past three or four years. The problem they have is the number of different types of indices. Some of them are cap weighted; some of them try and equally weight the four different countries; some of them will be narrow large-cap in terms of their overall weighting. All those different factors can actually give you ultimately different returns. So are you going to track BRIC with just the 50 Stoxx Index? Are you going to track it in a way that is capped in terms of your country exposure? Or do you want a market cap-weighted index which gives you full exposure to China and India, and Russia in the right proportions? I think that those are the issues that people need to understand, because otherwise you are simply looking at BRIC and the index name; you think that all BRIC indices might be the same and not have a true understanding of really the exposures.
EBM: And lastly, why are some indices weighted by GDP rather than by market cap, and what difference does it make for investors?
NH: Traditionally, all the indices are market cap weighted and one of the things that we look at in the guide is that if you go from just a developed market index to an all country index which includes emerging markets, on a market cap weighted basis, you add emerging market risk, but you have very little difference when it comes to your returns. GDP weighted indices are very interesting; they give you a long-run view of the exposure to GDP growth economically and give you a much higher exposure to emerging markets. There is a weighting of 30% in emerging markets in the GDP weighted index as opposed to 13% in the cap weighted index. We think that it’s an interesting, alternative framework that has some economic background to it that investors could us to gain greater exposure to emerging markets.
EBM: Nizam Hamid. Head of Sales Strategy for iShares in Europe, thank you very much.
NH: Thank you
