NEWS

Emerging Markets Internet & Ecommerce ETF: Bullish On The 'Light' Exposure To China

Jan 9, 2022
Artificial intelligence and communication network concept.

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The Emerging Markets Internet Ecommerce ETF (EMQQ) invests in companies from developing countries involved in areas like search, online retail, social networking, mobile payments, gaming, and travel. The attraction here is the growth opportunity from an expanding middle class in emerging markets (EM) with potentially billions of consumers gaining access to the internet for the first time. China is an important part of this theme representing about two-thirds of the fund which is further diversified with stocks from countries like India, Brazil, and Russia among others.

Despite the positive long-term outlook, it's been a challenging period for EMQQ ETF with a deep selloff over the past year. Some of that weakness has been related to a poor performance from Chinese stocks amid regulatory concerns in the country along with broader market volatility in high-growth tech segments. That said, EMQQ looks interesting following the correction given its unique exposure which balances the risks in China with high-quality stocks from other regions. Recognizing the ongoing uncertainties and getting past some of the near-term headwinds, we believe EMQQ can rebound in 2022.

EMQQ ETF

(Seeking Alpha)

What is the EMQQ ETF?

The EMQQ ETF technically tracks companies that derive a majority of assets and revenue from internet E-commerce activities. Other criteria include a float-adjusted market capitalization of $300 Million or greater along with a minimum level of trading volumes. The underlying index and fund have a modified market cap-weighted methodology with the largest positions capped at 8% during the semi-annual rebalancing and reconstitution.

As mentioned, the high-level theme supporting the outlook for the segment is a recognition that developing countries are still at an early stage of adopting the related internet technologies and transitioning towards digital services. The widespread availability and the falling price of smartphones mean that the internet and e-commerce are increasingly accessible to more people.

While 82% of the U.S. population own or have access to a mobile device, emerging economies are still at much lower penetration levels. With data from 2019, only 61% of the population in China had a smartphone device while other countries were like Brazil at 51% or India at 32% were farther behind. With an expectation that these levels converge higher globally over time, the numbers suggest hundreds of millions of new consumers that will eventually be online and taking part in e-commerce.

The other dynamic here is the demographics in emerging markets which are younger on average than in developed countries implying a longer runway for growth. Simply put, the companies within EMQQ are best positioned to capture these trends.

Smartphone penetration by country

(source: EMQQetf)

EMQQ Fund Composition

EMQQ has a tilt towards Chinese companies which represent 62% of the portfolio. South Korea with a 6.6% weighting, followed by India at 5.1% is the next most important country by weighting. A group of Chinese tech giants including Alibaba Group Holdings (BABA) and Tencent Holdings Ltd (OTCPK:TCEHY) each with a 9% weighting are the largest positions in the fund. Other high-profile Chinese companies like JD.com, Inc. (JD), Pinduoduo Inc. (PDD), and Baidu, Inc. (BIDU) are within the top 10 holdings.

EMQQ top 10 holdings

(source: EMQQetf)

India's "Reliance Industries Ltd" is a curious position in the fund with an 8.1% weighting considering the conglomerate is diversified across not only digital services but also a larger legacy business related to energy and petrochemicals. Nevertheless, Reliance is an important company within the broader theme of EM and is a good representative of the Indian economy.

Down the list of the entire portfolio, some interesting stocks include MercadoLibre, Inc. (MELI) out of Argentina but recognized as major e-commerce and online marketplace player in Latin America. There is also Russia's Yandex NV (YNDX), which has established a leadership position in Eastern Europe across internet search with a growing list of online services. There is a good diversification across 132 holdings in companies representing different tech segments. Finally, we note that EMQQ's expense ratio at 0.86% is comparable to thematic and industry-focused funds.

EMQQ Performance

With a fund inception date of November 2014, EMQQ has returned a cumulative 63% on a total-return basis, outperforming the more diversified iShares MSCI Emerging Markets ETF (EEM), up 39% in the period as a benchmark. This timeframe has been defined by significant volatility in EM. Even before the pandemic, the weakness goes back to the collapse of energy prices in 2014 that pressured growth in several commodity exporters and a stronger dollar. China, for its part, has been defined by a gradual slowdown over the period with overall softer than expected economic indicators.

EMQQ vs SPY price Data by YCharts

Even as "tech" within emerging markets has been strong over the past decade, the segment has underperformed global benchmarks like the SP 500 Index (SPY). 2021 was particularly rough with EMQQ down about 36% over the past year representing a significant underperformance to EEM down by a more moderate 7%. The challenge is in part related to the fund's exposure to Chinese internet stock that has been among the weakest part of the market.

The story in 2021 was a shift in the regulatory environment in China with the government taking a strict approach to regulation, targeting internet companies citing issues like data security, and anti-competitive practices. Companies like Alibaba, Baidu, and Tencent have been forced to pay record antitrust fines related to accusations of market abuses.

Beyond the actual near-term financial impact, sentiment towards the region has suffered leading to depressed valuations and large losses from the highs. In this regard, EMQQ was dragged lower in 2021 but still managed to outperform alternative China-only internet and tech funds like the KraneShares CSI China Internet ETF (KWEB) which is down by 51% over the past year.

EMQQ vs Chinese tech stocks price Data by YCharts

EMQQ ETF Forecast

Any bullish case for EMQQ going forward is going to need Chinese stocks as a group to regain positive momentum. There are a lot of uncertainties but a case can be made that the selloff has already priced in some of the worst-case scenarios. We can't predict what the Chinese government will do next, but there is a thought that going much further in terms of regulation to undermine private enterprise would end up having broader consequences to the overall economy. Simply put, we believe the Chinese government as rational actors will attempt to maintain a sense of stability in investments recognizing the importance to the financial system.

So when looking at EMQQ today, we like the fund because it can capture a turnaround in Chinese stocks, but with a notch lower in terms of its risk recognizing the uncertainties. EMQQ can represent a compelling alternative to KWEB for example by capturing the same high-level beta trends in Chinese stocks with an added diversification into other emerging markets.

We highlight that just within the top-10 holdings of EMQQ, 6 stocks representing 36% of the fund, overlap the top holdings in KWEB as the largest internet-specific fund targeting Chinese stocks. Down the list of holdings, the majority of Chinese stocks in EMQQ are also KWEB holdings, but essentially underweight.

EMQQ vs KWEB top 10 holdings

(Seeking Alpha)

EMQQ can be seen as a "light version" of a Chinese internet stock fund. In an environment where Chinese stocks underperform, we can expect EMQQ to be more resilient with less downside. Over the past 3-years EMQQ has returned a positive 47% compared to a decline of 8% decline from KWEB. In a scenario where Chinese stocks get very bullish, EMQQ may lag Chinese-specific funds slightly, but will nevertheless still participate in the rally.

EMQQ vs KWEB price Data by YCharts

The major development in the market during the early part of 2022 includes the resurgence of Covid disruptions through the Omicron variant. Favorably, reports suggest the vaccines remain effective and symptoms are milder than previous strains of the virus. The upside is an opening where Omicron can ultimately represent the end of the pandemic considering rising vaccination rates and trends towards herd immunity. If true, we can expect the global economy to resume its post-pandemic recovery with emerging markets leading growth higher.

According to estimates International Monetary Funds (IMF), emerging markets and developing economies are expected to grow GPD as a group by 5.1% in 2022 compared to 4.5% in developed markets. Our takeaway is that this is a positive backdrop for the EMQQ ETF going forward.

World Economic Outlook

(source: IMF)

Final Thoughts

Overall, EMQQ is a high-quality fund with an interesting strategy targeting a high-growth market segment. Despite the extreme volatility over the past year, we believe the cards are in place for a rebound going forward supported by a positive long-term outlook. We are bullish on EMQQ which we believe can work for exposure to both EM and China in the context of a more diversified portfolio.

The main risk to consider is the possibility of a broader macro slowdown. Weaker than expected global growth, as a result of deeper and longer-lasting Covid disruptions would likely add to weakness in the segment and further pressure sentiment in the fund. Headlines out of China also have the potential to move the market.

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