SMA Vehicles Facilitate New Retail Investment Opportunities in Emerging Markets Poised for Growth

Separately managed accounts (SMAs) keep gaining in popularity – and flows. Top asset management firms are adding new options at lower minimums, attracting savvy investors with high-quality products that offer more differentiation and service than classic mutual funds.

At the same time, many investors are seeking (wisely) to diversify their equity exposure as the U.S. bull market charges into its historic 10th year. To meet their desires and needs, asset managers are providing innovative and cost-effective SMA offerings that feature diversified international equity strategies, many focused on emerging markets (EMs).

Macroeconomic forecasts for EMs are highly favorable. By 2030, seven of the world’s 10 biggest economies are predicted to be EM countries. Higher gross domestic product (GDP) growth creates opportunities, and while average GDP growth over next five years is projected to be a tepid 1.7 percent in developed economies, EM economies expect to grow at a much faster rate of 4.8 percent.

This will lead to a significant shift of the world’s middle-class population away from (North America and Europe) or (Developed Markets) to the Emerging Markets, particularly in India and China. The resulting growth in disposable incomes will create opportunities in many industries such as consumer, financial services and technology

We’re already seeing that impact change the sector leadership in EM indexes. While in 2008, resources sectors comprised about a third of the MSCI Emerging Markets Index, today they are half that. We have seen the index shift to higher quality companies with higher and more sustainable returns on capital in sectors like Technology and Consumer, which have gone from 19% to 35% of the benchmark

However, this shift hasn’t been rewarded by investors as EM trade at attractive valuations relative to the developed world

EMs were historically a challenging asset class for SMA product development, but Legg Mason developed an SMA that takes advantage of access ordinary shares via the no-fee funds and American depositary receipts (ADRs) to enhance the available offerings.

Previously, SMA programs could hold EM stocks only as ADRs, which is a limited universe of stocks. As an example, the three largest countries in EM, outside of China, are South Korea, Taiwan and India, which account for about a third of the index. There are nearly 300 stocks in those countries yet less than 20 ADRs. By combining a no-fee 1940 Act mutual fund structure within an SMA, investors can now access compelling ordinary share stocks from the full breadth of the emerging market universe, avoiding the potential limitations of ADR-only portfolios.