How to Use the MSCI Emerging Markets Index for Investing Decisions: Step by Step Guide

... Credit :
Jane Taylor in Business & Finance

Last updated: 21 January 2020, 07:00 GMT

The MSCI emerging markets index (MSCIEF) selects high relative liquidity stocks with significant volume in the emerging markets.

MSCI's emerging markets index’s composition attempts to efficiently and accurately track the underlying emerging markets equity universe. That’s why MSCI Barra, the manager of the MSCI emerging markets index, wants as many individual stock names as possible to represent emerging markets equities.

Managers want to maintain the right number of representative stocks in the emerging markets to enable mutual funds and exchange-traded funds to mimic them. Emerging markets indexes can inform investing decisions. The following sections offer a step-by-step guide on how to use the MSCI emerging markets index.

What Is the MSCI Emerging Markets Index and How Does It Work?

If you want to participate in the tremendous growth potential of the emerging markets and limit the risk of owning stocks in these markets, consider an emerging market index investment. The MSCI emerging markets index (MSCI EMI) has increased more than 20 percent over the last year. Over the past decade, the MSCI emerging markets index has generated a 9.16 annualized return.

Many investors invest directly in the MSCI emerging markets index or in mutual funds, ETFs, options, and futures that reflect it. More than two trillion dollars is currently invested in 23 emerging countries' stock markets. The index allows investors to own the broad swath of equities in the emerging markets. So using the index or its derivative adds instant diversification to the portfolio without the expense of buying the underlying stock names.

According to managers, the MSCI emerging markets index represents large and middle-capitalization companies in 23 emerging markets countries. As of February 28, 2017, the index tracks 832 constituents and covers about 85 percent of the free float-adjusted market capitalization of each emerging market country. The index adds the total value of the constituent stocks’ market capitalization, or each stock’s market price times the number of its outstanding shares. Managers maintain the MSCI emerging markets index but don't actively manage it.

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7 Tips On Profiting From the MSCI Emerging Markets Index

1. Use the MSCI Emerging Markets Index to Avoid Risky Stock-Picking

Don't fear an index product. If you invest, it's comforting to know that the S&P 500 index (but not the DJIA) is constructed using precisely the same methodology. The MSCI emerging markets index market caps are computed in U.S. dollars. They are also in a local currency, to give investors an idea about the index’s performance with exchange rates’ impact.

Market caps of the index are updated each trading day, Monday through Friday. The index is reviewed each quarter and re-balanced twice per year. Decide how you want to invest in the index to capture the broad market for emerging markets stocks.

2. Re-Balance to Decrease Risk in the Emerging Markets

Re-balancing is especially important in emerging markets because it ensures that original target allocation percentages are maintained. It's an important risk management tool. The manager adds or subtracts stock names. Then, the index continues to accurately reflect the composition of the underlying markets it measures.

3. Power Up Your Portfolio

For that reason, the MSCI emerging markets index has the power to change or impact the market. If you're an emerging markets investor, this fact is important to know. When the MSCI adjusts, mutual funds and ETFs tracking it must sell or buy the same stocks.

The bottom line effect is that when the MSCI emerging markets index has new stock, its price is likely to go up. If the stock drops from the index, its price usually declines.

4. Consider Your Market Perspective

About 22 percent of the MSCI emerging markets index is invested in 10 constituents. Importantly, the top four constituents (Samsung, Taiwan Semiconductor, Tencent Holdings, and Alibaba Group) are information technology stocks. Baidu ADR and Hon Hai Precision (currently ranked 9 and 10) are also in the infotech sector.

This is why some investment managers say that's a good thing. In fact, affluent and middle-class families are trading up to premium Western, regional, and local goods and services. These names highly correlate to the U.S. and Western markets. However, they're active trade partners to technology names in the developed markets.

A higher correlation may reduce the emerging market exposure you're looking for in that case. You may prefer to buy a small-capitalization index, such as the MSCI emerging markets small-cap index.

5. Hedge Your Bets in Emerging Markets

For instance, if your investment in the MSCI emerging markets index has increased over time or if you own individual emerging markets assets, use long and short options to hedge against risks. These can be interest rates, exchange rates, and other unknowns. This strategy is similar to writing calls or purchasing calls. Therefore, this puts on individual stock names in the portfolio. However, using index options is typically a more cost-effective portfolio insurance strategy.

6. Choose the Way You Want to Invest in the MSCI Emerging Markets Index

IShares MSCI Emerging Markets ETF (EEM) has returned more than 12 percent YTD to investors. The ETF format allows you to buy and sell shares like stocks whenever you'd like.

7. Compare Emerging Markets Assets to the MSCI EMI Benchmark

Lots of professional investors do. For example, JP Morgan's Emerging Markets Equity fund overweights the index. It's commonly used as a measurement of emerging market performance. If you want to gain exposure to emerging markets stocks but don't have access to local markets research, you're buying the performance of a highly diversified emerging markets stock portfolio.

Summing It Up

There are many reasons to invest in emerging markets stocks and financial assets. The MSCI EMI is more volatile than market investment. Let's take 2003 as an example. Then, the index returned more than 50 percent to investors. During the Global Recession, the MSCI emerging markets index lost more than 53 percent in 2008. Timing any market is challenging. Time in the market is more meaningful. Investing in emerging markets isn't for everyone. Most financial advisers recommend a long-term horizon for investors in the emerging markets.

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