Emerging market indexes are becoming ever-more concentrated in east Asia. That isn't necessarily a good thing for investors that track these benchmarks, according to Parametric Portfolio Associates LLC.
A better strategy is to reduce weightings to big countries like China so as not to be too exposed to just a few places, and look to the likes of Kenya and Sri Lanka for a more balanced geographic allocation, according to Parametric, a systematic fund manager overseeing $216.6 billion of assets for parent Eaton Vance Corp.
"The default portfolio is very concentrated in Asia right now," Paul Bouchey, co-chief investment officer at Parametric, said in a phone interview on Wednesday. "We're definitely going farther afield" to diversify.
Parametric believes that recent changes have left investors too exposed to Asia, and MSCI's plans to quadruple its current holdings of Chinese A-shares in its emerging-markets index will exacerbate the issue. The combined weighting of China, South Korea and Taiwan in the MSCI EM gauge is about 53% as of Feb. 28.
Parametric is underweight all three of those markets and makes up the difference in smaller countries, Bouchey said.
The fund manager is looking at Saudi Arabia, which currently exists in a standalone category and will be included in MSCI's emerging index later this year. He also mentioned Kenya and Sri Lanka, both considered frontier markets, and Eritrea, which is not categorized by MSCI at all.
In theory, investors who evenly balance allocations by market capitalization should be rewarded with a risk premium, said Puneet Singh, head of Asia-Pacific equity quant research at Societe Generale in Hong Kong.
"In general, equal weighting outperforms cap weighting simply because you are taking on more cap risk and liquidity risk," he said. "Theoretically, this concept extends to countries as well."
