New Economic-Exposure Indexes Look Sweet

By Dennis Hudachek,

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I've always thought that an "emerging markets" ETF consisting of only U.S. or developed-market companies that get a bulk of their revenues from emerging markets would resonate with investors-in essence, a "developed-companies, emerging markets ETF."

That's exactly what MSCI and Russell are aiming to tackle in their relatively new economic and geographic exposure indexes. In short, these new indexes target a specific country or region not based on where the company is domiciled or listed, but on the company's revenue source.

Not much has been discussed about these indexes, nor do many folks yet know that they even exist, but I think MSCI and Russell are on to something new and potentially big here.

In an increasingly global financial market, more multinationals are getting a majority of their revenues from outside their own borders. For example, from a brand-name perspective, Coca-Cola is as American as apple pie. But from a revenue perspective, it's not as clear, with the soft drink company getting more than half its revenue from outside the United States.

In an extreme case, Nestle gets less than 5 percent of its revenues from Switzerland, but gets 35 percent of its revenues from emerging markets, according to MSCI. Does it still make sense for Nestle to be only included in the MSCI Switzerland index?

The list goes on. Think of companies like Unilever, McDonald's, Yum Brands, Nike, Estee Lauder, Pepsi and Adidas. While there have been numerous debates surrounding country classification (e.g., South Korea), little has been talked about regarding whether investors are truly getting complete exposure to emerging markets.

This is especially true in the consumer space.

Emerging-markets-consumer ETFs are gaining in popularity-for example, the EGShares Emerging Markets Consumer ETF (NYSEArca:ECON) is now a $1.1 billion fund. Still, the truth is, many of the top consumer brands in emerging markets are no longer necessarily local companies.

As emerging markets consumers gain more purchasing power, consumers are increasingly choosing "foreign" brands as a status symbol, if not because of the "cool" factor, especially with the younger generation. The sporting goods sector in China is a case in point. Nike and Adidas have long surpassed local brands in China in terms of revenues.

The Indexes

MSCI first launched its economic-exposure indexes in March 2012, starting off with five developed-market benchmarks targeting emerging markets exposure, including the MSCI World with EM Exposure Index and MSCI USA with EM Exposure Index.

Since then, the indexing juggernaut has launched 13 more, included indexes targeting Asia, China and Africa, as well as a comprehensive emerging markets index that pulls from both developed and emerging markets, the MSCI ACWI with EM Exposure Index.

To determine a company's economic exposure, MSCI considers a company's emerging markets multiplier-based on the proportion of the GDP weight of emerging countries relative to the region as a whole-and the percent of revenues from the region.

Meanwhile, Russell first launched its GeoExposure Indices in September 2012. Russell currently has four indexes targeting emerging markets exposure from developed-market indexes, including the Russell 1000 EM GeoExposure Index.

Russell determines a company's economic exposure to a region by incorporating both the total revenues in dollar terms and the percentage of revenues, derived from the region. It then determines a composite score based on a weighted average of the following:percentage of revenues (50 percent); revenues in dollar terms (25 percent); and market cap (25 percent).

Concluding Thoughts

Whether these indexes take off is yet to be seen, but they certainly open up a new angle regarding what constitutes total emerging markets exposure. At the least, I think it's a good time for investors to start thinking about corporate revenues in a globalized world.

After all, from a purely exposure perspective, does it matter where the company is domiciled if a significant chunk of their revenues are from emerging markets? Shouldn't these types of companies carry some weight in an enhanced EM index?

For example, the MSCI ACWI with EM Exposure Index looks particularly attractive in this arena, as it doesn't limit itself to emerging or developed-country classifications, but simply measures the revenue exposure to emerging markets of all global companies.

Indexing is certainly evolving, and I wonder if one day these types of indexes could be the next-generation market-cap weighted indexes. There are currently no filings from ETF issuers to track these new benchmarks, but it wouldn't surprise me to see a few in the near future.

At the time this article was written, the author had no positions in the securities mentioned. Contact Dennis H udachek at

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing ETFs
Referenced Stocks: ECON

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