For many years, Canada’s stock market was a proxy for emerging-market equities. In both markets, energy and materials have played an outsized role.

By the end of 2009, these two sectors combined comprised almost 30% of the MSCI emerging markets index (MSCI EMI) and 43% of the S&P/TSX capped composite index (S&P/TSX CCI). Financials was the heavyweight sector, constituting 24% and 30% of both indices, respectively.

Times have changed. In emerging markets, information technology (IT) now is the heavyweight sector, comprising more than 28% of the MSCI EMI as of Oct. 31. In fact, six of the top 10 stocks in this index are tech companies, including American depository receipts for Samsung Electronics Co. Ltd. and Alibaba Group Holding Ltd. Energy and materials have shrunk by more than half to 14% of the index while the combination of consumer discretionary, consumer durables and health care has grown by more than 75% to comprise 19% of the index. Financials continues to weigh in at 23% of the MSCI EMI.

In Canada, IT has gone nowhere, comprising a paltry 3.3% of the market, while energy and materials combined represent 31% of the S&P/TSX CCI. Financials has swollen to 35% of the market, and four of the top 10 stocks in the index are banks. Consumer discretionary, consumer durables and health care have grown, but this combination still comprises only 10% of the S&P/TSX CCI.

These sectoral differences are reflected in recent stock performance: technology stocks shine. For the 10 months ended Oct. 31, the MSCI EMI was up by 27.5%, far outpacing the 7.3% return of the S&P/TSX CCI in the same period. Over the past 12 months, the correlation of the S&P/TSX CCI and the MSCI EMI has been slightly negative, at -0.02; this is a marked contrast to the positive correlations of Canadian stocks with U.S. and international equities. Emerging markets increasingly march to their own beat and constitute a source of diversification for Canadian investors.

In addition, emerging-market stocks are cheaper than Canadian stocks by several metrics. The MSCI EMI’s forward price/earnings ratio is 14.0, price/sales ratio is 1.4 and price/free cash flow ratio is 13.7; compare those to Canada’s ratios of 17.8, 1.8 and 17.1, respectively, as of Oct. 31. Yet, the anticipated economic growth for emerging markets is much stronger than expectations for Canada.

Emerging markets are riskier than Canada’s market. Drawdowns have been deeper and longer and, although the volatility of the MSCI EMI has diminished during the past decade, that index remains higher than that of the S&P CCI. At a macro level, a pronounced slowdown in China’s economy is an ever-present risk.

A historical barrier to investing in emerging markets has been the high fees of actively managed mutual funds. With the advent of low-cost ETFs, this is no longer a hurdle. In the U.S., iShares Core MSCI Emerging Markets ETF has a management expense ratio (MER) of 0.14%; meanwhile, in Canada, Vanguard FTSE Emerging Markets All Cap Index ETF has an MER of 0.25%. There also are a host of factor-based emerging-market ETFs available, including high-dividend, value, low-volatility, quality and small-cap ETFs.

Michael Nairne is president of Tacita Capital Inc. of Toronto, a private family office and investment-counselling firm. The company, its principals, employees and clients may own the securities mentioned herein.

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