EMXC: A Beneficiary To Global Supply Chain Readjustment (NASDAQ:EMXC)

Introduction

Tensions between China and the U.S. have risen considerably in the past few years. As a result, some investors may not be comfortable investing in emerging markets funds that include China. Fortunately, iShares MSCI Emerging Markets ex China ETF (NASDAQ:EMXC) is one fund that invests in emerging markets that exclude China. In this article, we will look closely at EMXC and provide our analysis and recommendation.

Investment Thesis

EMXC invests in about 720 large-cap and mid-cap stocks in emerging markets, excluding Chinese stocks. The fund’s exclusion of China is beneficial as the country is going through some rough water. The escalating tension between China and the U.S. will also result in continual global supply chain readjustment. This will benefit many emerging markets that EMXC has exposure to. The fund’s exposure to information technology sector will also be beneficial, as this sector should have outsized growth than many other sectors. Therefore, we think EMXC is a good fund to own for investors seeking to invest in emerging markets.

Fund Analysis

Performance analysis since its inception

Let us first review how EMXC performed in the past. As can be seen from the chart below, the fund has gradually climbed out of the cyclical low reached in late 2022, but has not yet surpassed the peak reached in late 2021. However, EMXC’s fund price has been in an upward trend since the cyclical bottom and is poised to continue to trend higher. EMXC has delivered a total return of 35.2% and price return of 15.5% since its inception in 2017.

EMXC’s exclusion of China should be favorable in the upcoming decade

Since this is a fund that is basically designed for investors who want to invest in emerging markets but do not want Chinese stocks, we need to first discuss the impact of excluding them. We actually like EMXC’s exclusion of China, as China’s economy is facing many uncertainties. Here, we will quickly highlight a few. First, China is currently going through a housing bubble burst. This is evident in the fact that the number of housing starts has fallen considerably from the peak reached in 2020. In fact, as the graph below shows, the number of housing starts has declined by more than 50% since 2020.

Second, China’s population is now entering a phase of decline. A declining and ageing population is not good news for the economy as it will hurt its services sectors and that the country may need to combat against deflation.

Third, the escalating tension between China and the U.S. has caused many U.S. companies to reorganize their supply chain and reduce their exposure to China. This will also hurt China’s export industries.

Let us compare EMXC with its peer fund, iShares MSCI Emerging Markets ETF (EEM), which has similar holdings except EEM also includes Chinese stocks. As can be seen from the chart below, EMXC’s total return of 35.2% since its inception in 2017 was better than EEM’s 15.3%. Based on our discussion, we think EMXC’s outperformance to EEM will continue as China clearly needs to go through some rough path ahead: a housing bubble burst, a declining population, and global supply chain readjustment.

We like EMXC’s exposure to Taiwan, and South Korea

Let us now look at EMXC’s geographical allocation. As can be seen from the table below, Taiwanese stocks represent about 26.5% of its portfolio. This is followed by Indian stocks’ 25.2% and South Korea’s 16.2%. Together, stocks from these three countries represent nearly 68% of its total portfolio.

We noted that Taiwan and South Korea both have a vibrant technology industry. In fact, EMXC’s top 2 holdings come from these 2 countries. The largest holding is Taiwan Semiconductor Manufacturing Corporation (TSM), which represents about 13.3% of EMXC’s portfolio. The second-largest holding is Samsung Electronics (OTCPK:SSNLF), which represents about 5% of the portfolio.

EMXC’s high exposure to Taiwan and South Korea stocks means it also has a high exposure to technology sector. In fact, the information technology sector represents nearly one third of EMXC’s portfolio. This exposure should be favorable as technology sector is expected to grow its earnings at a faster pace than many other sectors in the upcoming decade as the sector will benefit from many technological megatrends.

Many emerging markets will benefit from global supply chain readjustment

As we have mentioned earlier in our article, tensions between the U.S. and China have resulted in ongoing global supply chain readjustment. This means that China’s status as the world’s factory will gradually be weakened, and many other countries will benefit. For example, we have observed Apple (AAPL) demanding its subcontractors to open new facilities in India to manufacture iPhones. Even Tesla (TSLA) is thinking about setting up a factory in India. Southeast Asia is also another region where many factories will relocate to, as the region still has plenty of labour force. Even Mexico will benefit from this trend as the country will benefit from a new North American trade agreement between the U.S., Canada, and Mexico. Therefore, we think EMXC will benefit from a long-term tailwind of global supply chain readjustment.

Investors should not ignore geopolitical risks

Having said enough about the benefits of owning EMXC, we need to also mention one important risk: geopolitical risk. This risk is hard to predict. Before the Russian invasion of Ukraine, The Economist in their May 2021 issue named Taiwan as the most dangerous place on earth, as they think China will one day invade the island before 2027. Well, the invasion has not yet happened, but the war between Russia and Ukraine, and the war between Israel and Hamas broke out first. Whether the invasion from China will happen or not remains a question. However, EMXC’s exposure to Taiwan is more than a quarter of its portfolio. Therefore, it is certainly a risk for investors to consider. In any case, we think investors of EEM will have higher risk than EMXC as EEM also includes Chinese stocks. In fact, Chinese stocks and Taiwanese stocks represent about 45% of EEM’s portfolio. An invasion of Taiwan will likely result in international sanctions against China, and China’s economy will be hit hard as well. Therefore, we think investors of EEM’s impact will be much more severe than investors of EMXC. Hence, EMXC’s geopolitical risk, is likely going to be lower than EEM.

Expense ratio lower than EEM

One last item we want to mention before we wrap up this article is EMXC’s expense ratio. Initially, we thought EMXC’s expense ratio will be similar to EEM’s 0.7%. When we look at EMXC’s fund information, we noted that the fund only has an expense ratio of 0.25%. A 0.45% difference may not be a lot, but can still accumulate up to 4.5% in a decade (assuming the fund price remains the same).

Investor Takeaway

We like EMXC’s exclusion of Chinese stocks, as China’s economy is going through some rough water ahead. The escalating tension between the U.S. and China will result in an ongoing global supply chain readjustment, and this will benefit many emerging markets except China. EMXC’s high exposure to the information technology sector is also beneficial, as this industry is certainly going to benefit from many technological megatrends. Therefore, we think EMXC is a better fund to own than EEM.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.