The growth of Chinese tech stocks, which is driven by two companies Alibaba and Tencent, has posed increasing concentration risks for the emerging markets index, according to Realindex.
The firm’s paper ‘China Tech and the Rising Concentration Risk in Emerging Markets’ revealed that a select few Chinese internet behemoths had become increasingly dominant in MSCI’s Emerging Market cap-weighted index.
Further to that, it suggested alternative weighting schemes could reduce this level of concentration risk and modelling show that Realindex’s EM accounting-weighted portfolio, based on sales, book value, cashflows and dividends, delivered a more evenly-weighted outcome.
The paper also pointed out that China tech firms were significantly more expensive than the rest of the market, trading at a P/E ratio of circa 40x, in contrast to the rest of the index where P/E ratios were circa 20x.
According to Realindex’ quantitative analyst Wang Chun Wei, the increasing weight in Chinese technology firms resulted in the whole EM market capitalisation index becoming ‘pricier’.
“The growth of China in the index is broadly in line with its gross domestic product (GDP), so that’s not the key issue here. What matters is that most of China’s outsized impact is driven by just two companies: Alibaba and Tencent,” he said.
“The concentration risk of these tech and e-commerce companies has been increasing rapidly over the last 10 years, and looks set to continue. Moreover, the recent abrupt suspension of Jack Ma’s US$35 billion ($47.8 billion) Ant Financial (fintech) IPO in Hong Kong highlights the regulatory risks of investing in China,” he said.
“The rise of Chinese tech firms has brought about imbalances to the market cap weighted index for emerging markets. We expect to see this trend continue with the potential IPOs of Didi Chuxing and Ant Financial into Hong Kong. Therefore, it is not unlikely that China’s risk contribution to MSCI EM could well be over 50% in the near future, with even greater concentration risk to ‘tech’ names.
“We urge passive EM investors to be aware of these risk exposures, and show that alternative weightings can alleviate some of these concerns.”
