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Are Argentina and the Ukraine emerging markets?

Reading a Financial Times article about emerging markets over the weekend by John Redwood (the former Conservative government minister and Chairman of the Investment Committee at Pan Evercore) reminded me of a few recent conversations with clients on the same subject. These conversations tend to have been prompted by media coverage of the recent geopolitical tensions in the Ukraine – which have rarely been out of the news since the shooting down of flight MH-17 – or the saga over the recent Argentinian debt default.

The same conversations have been useful reminders for me that whilst most clients know that they have an emerging markets allocation in their portfolios , they do not always understand what countries these are drawn from, and how we actually go about investing in them to try and ensure that the clients get the best investment experience. It may be reassuring to note that neither the Ukraine or Argentina come under the MSCI classification for their emerging markets index which is followed by the majority of mutual fund managers and currently covers 23 markets.1

Disclaimer: The value of an investment and the income from it could go down as well as up.

Furthermore , the mutual fund that we use for emerging markets exposure (The Dimensional Fund Advisors – “DFA” Emerging Markets Core Equity Fund) has its own strict country selection criteria including; liquidity at the exchange and individual security levels, market capitalisation, market regulation, settlement practices, listing requirements, repatriation and other foreign restrictions and taxes. DFA will not invest in every country in the MSCI index and before any country can be added or removed it must first go through their global investment committee.

In particular countries the local stock market may be avoided , and in those emerging markets that do not meet the firm’s requirements for direct investment, alternative means of investment are used. For the Emerging Markets Core Equity Fund, investments in Columbia, Egypt, Peru and Russia are currently restricted to American Depositary Receipts (ADRs) and Global Depositary Receipts (GDRs) traded on approved exchanges in other approved markets such as the UK. Depositary receipts that trade in London meet the listing requirements and other regulations of the London exchange.

Similarly, in China DFA are currently restricted to Chinese equities that trade in markets outside of mainland China, including but not limited to: (a) H Shares and Red chips traded in Hong Kong, (b) N shares and ADRs traded in U.S., (c) GDRs, and ETFs traded on approved exchanges in other approved markets.

Depositary receipts are traded primarily through the New York, London and Hong Kong exchanges. DFA goes a step further and only considers companies that conform to international accounting standards and have a market capitalisation of at least $250 million.2

This practice allows the manager’s strategies to gain exposure to the performance of equities across many emerging markets countries while avoiding potential risks in some of the local exchanges.

2(Source for preceding paragraphs: DFA, Recent Enhancements in Dimensional’s Emerging Markets Strategies, Greg Headley, September 2010)

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