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FRANKLIN TEMPLETON EMERGING MARKETS EQUITY

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We believe the emerging-market (EM) small-cap space is an attractive proposition in the current investment climate. However, there are some common misconceptions regarding the asset class which, in our view, conceal key strengths that an active manager could benefit from. These include:

  • Misconception #1: EM small cap is a niche asset class:
    Contrary to this misconception, EM small caps constitute a vast investment universe with ample liquidity. The asset class represents more than 32,158 companies with an aggregate market capitalization of over US$7.9 trillion and daily turnover of over US$44 billion.1 Liquidity within EM small-cap markets is comparable to that of EM large caps.
  • Misconception #2: EM small caps are more volatile:
    Despite this view, data demonstrate volatility for EM small caps is not necessarily higher than for larger EM stocks.

In addition, the EM small-cap space has a number of other potential opportunities for active investors to take advantage of, in our opinion, including:

  • It is under-researched and under-owned:
    Given the size of the investment universe, there is generally a limited research coverage
  • Recapturing local growth:
    Large-cap EM equities are heavily skewed to sectors such as information technology and financials that can be more closely impacted by global or country-level macroeconomic trends. However, EM small caps have performance drivers that are more likely to be determined by domestic demand, favorable demographics, local reform initiatives and innovative niche products. An active approach can seek out the attractive growth opportunities among small caps, while also having the flexibility to find prospects that have access to appealing global growth potential.

Overall, we believe the above points present an attractive prospect for active managers as we believe a multitude of mispriced securities, market inefficiencies and a paucity of research provide considerable opportunities for seeking alpha generation.

ENDNOTES

  1. Source: Bloomberg, MSCI, as at 09/30/18.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a portfolio focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a portfolio that invests in a wider variety of countries, regions, industries, sectors or investments. Investing in smaller company securities that may have limited liquidity involves additional risks, such as relatively small revenues, limited product lines and small market share.

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