Client Portals

Get State Owned Enterprises Out of Emerging Markets2 min read

Dec 31, 2019 - John Osbon ( 4 mins to read)

John Osbon

Emerging markets are an important asset class that include major countries with massive populations like China and India. Emerging market investments have been accessible for decades, but they’ve often included state-owned enterprise (SOE) holdings — whether you’ve wanted them or not. Maybe you didn’t. State Owned Enterprises are notoriously inefficient, often conflicted and sometimes even overtly corrupt. It’s possible to invest in emerging market funds without these SOEs. Let’s take a deeper look.

Separation has begun

A majority of SOE holdings in emerging markets come from China, Russia and Brazil, with the leading sectors being financials and energy. A move is underway to weed them out of ETFs, but it’s just getting started. Given the choice, I would not invest in companies like China Construction Bank, China Mobile, Sberbank, Gazprom and Petrobras, among others. Many of these companies have obvious well-known examples of fraud and corruption that would not pass the standards of US rule of law. That’s where the inefficiency ultimately originates.

I expect that the two biggest emerging market ETFs, VWO (Vanguard) and EEM (BlackRock) will consider SOE filters in 2020. XSOE by WisdomTree is leading the way on this non-SOE investment thesis. This would be a big step forward but it’s a natural next step for those providers to consider. Until then the expectation is that non-state owned enterprise companies will carry the performance (as they have).

Why the distinction is important

There are five years of actual ETF performance with one ETF that excludes SOEs. Already we can see outperformance when we exclude the SOEs. I believe the performance trend will continue due to popular demand both from investors and from governments not wanting to endorse inefficient investments. The United States is leading the way right now in trying to exclude Chinese SOEs from as many areas of business as possible. The passage of the Magnitsky Act in 2012 has also made it harder for criminally inspired Russian companies to operate publicly.

A note on expenses

Non-SOE Emerging Markets investments are available with low cost-efficient expense ratios. And they can be traded for free now that commissions have been reduced to zero. If you want to get ahead I recommend starting with a discussion with us about the tax and allocation impact within your portfolio as a whole.

Know what you own

The SOE issue is another great reminder that it’s essential to know what’s really in your investment portfolio. ETFs with similar names may hold very different securities, especially in emerging markets where potential holdings vary widely across different countries (China vs. Poland vs. Argentina). It’s crucial to look under the hood and see what’s actually in there. Understanding what’s in every investment is an obsession of ours at Osbon Capital. We’d be happy to share what we’ve learned.

WEEKLY INSIGHTS
delivered to your inbox

DISCLAIMER

This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”

“Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.

Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.

Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.

This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.

While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.

Adviser does not endorse the statements, services or performance of any third-party vendor.

Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.

Any IPO alerts are purely informational and should not be construed as recommendations to invest.

Adviser is not licensed to provide and does not provide legal, tax or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.

Any case studies or hypothetical client profiles are for demonstration purposes only. They illustrate the breadth and depth of the many clients we represent at various life stages. Any similarities to actual Adviser’s clients past or present are strictly coincidental. Individual advice and results will vary based on each client’s circumstances, objectives and prevailing economic conditions.