It is well known that one of the key issues in investing in an emerging market is the relative lack of transparency. Those that attempt to generate more transparency - index providers for example - have their work cut out. Ali Zaidi and Fraser Hughes share their experiences.

It is clear that emerging markets offer investors a new set of interesting opportunities. These are the growth markets of the future. However, these markets also in face a number of challenges both at the broader local market level and at individual company level. At company level, it is clear significant work is required in reporting and transparency.

The FTSE EPRA/NAREIT Global Emerging Markets Index will provide investors with a proxy to benchmark funds against this specialist sector. Over 18 months of analysis and research has resulted in a structure that fits within the current FTSE EPRA/NAREIT Global Real Estate Index and the broader FTSE Global Equities Series.

The ground rules have evolved over this period to ensure that only bona fide real estate companies enter the index. These companies, or constituents, must be of a size that investors find both representative and investable; and each constituent must offer investors the ability to trade positions effectively. All constituents must report in English.

The table (right) highlights the emerging markets countries that will be covered by the FTSE EPRA/NAREIT Global Emerging Market Index. Broadly, three regions are covered: Asia-Pacific, Europe, Middle East and Africa (EMEA) and The Americas. In total, 24 countries are included on a global basis. The first column1 provides an estimate of the total size of the underlying investment quality real estate market, excluding residential. Asia-Pacific is the largest region with approximately US$2trn. Mexico and Brazil are by far the largest countries in Americas and Russia the largest in Europe. Total estimated size of the four regions is approximately US$ 3.4trn (€2.3trn).

The listed markets are developed to varying degrees. The second column highlights the full market capitalisation of each of the emerging countries. The third column displays the percentage of the underlying real estate market that is listed. For example, of the Chinese market approximately 10% is traded on the stock exchange. At a regional level, over 20% of African underlying real estate is listed. Asia-Pacific is approximately 6%, Europe 3% and the Americas extremely low at 20bps.

The final column indicates the market capitalisa tion proportion of the local stock exchange that is real estate related. Asia-Pacific listed real estate in total is just over 2% of broad stock market capitalisation. Africa hits 3.6% but Europe and the Americas are extremely light - 80bps and 6bps respectively.

Real estate investment trusts (or REITs) have established themselves as the major investment vehicle for institutional and retail investors in matured markets. Currently, of the countries to be covered by the FTSE EPRA/NAREIT Emerging Market Index, almost half of the markets have a recognised REIT structure in place2. The table (left) highlights the countries with REITs in place and indicates some of the main elements of the structures. In addition, we understand that discussions are ongoing in India and China in relation to the introductions of REIT structures. Perhaps the next 24 months will see the launch of an Indian and Chinese REIT?

A number of obstacles were dealt with during the design phase of the emerging markets index. The main problem was the absence of English reporting by the vast majority (80%) of the stocks included in the universe (approximately 1,200 stocks).

The main culprits are from China, Taiwan, South Korea, Egypt and Peru - these companies providing a very limited level of investor-grade annual reports and accounts in English. For example, a number of these companies published independently audited set of accounts in English, however supplementary information was omitted. It is worth noting that in a number of cases, the company financial statements where inconsistent on a year-on-year basis.

When digging deeper into the statements, the poor or non-existent breakdown of business segments hampers the clear analysis of relevant real estate eligibility. This issue is particularly common for Asian stocks, where construction, development and contractual activities are often reported under a single segment.

In general, analyst coverage on the emerging market is poor. This was particularly evident when conflicting figures were provided by different data vendors. In many cases, a particular company was not covered by a single analyst and the ability to verify information becomes challenging to say the least. Company website information was patchy at best. For example, Indian company websites were specifically designed to serve customers rather than investors - in many cases the investor relations department was non-functional or difficult to obtain relevant information from.

In general, when analysing the business strategy of companies within the emerging markets, there is little attention to business focus. In many cases, the company will be involved in the financing, construction, operation (hotels and leisure), development and management of the business.

When analysing the FTSE EPRA/NAREIT definition of relevant real estate, construction and operational activities are not eligible. The key is to carefully analyse company eligibility to ensure the portfolio, or index constituents, is representative of the commercial real estate market only.

The issues experienced in the reporting standards of companies and the level of transparency thereof, meant that strategic holdings by investors and insiders were difficult to access. Subsequently, the ability to establish accurate and reliable free float (7) information was extremely difficult. This was apparent across the majority of countries in the emerging markets. It was clear from our research that companies need to address the quality of their reporting, in some cases, drastically.

Liquidity or the tradability of stocks is also an issue in the emerging markets. This is of course inextricably linked to the free float difficulties mentioned above. For the three regions, Asia Pacific, Europe, Middle East and Africa, and the Americas, approximately 70% of the companies analysed failed the minimum requirement for liquidity. The ability to trade in and out of positions efficiently is a pre-requisite for fund managers with exposure to the emerging markets.

Investors are primarily interested in companies that are liquid and offer a degree of scale. Therefore, each company is tested on its relative size to the total size of its region of listing. This test was particularly a limiting factor for the Asia region as it led to the exclusion of 40% of the companies.

There are two reasons for this: firstly, a large number of small cap stocks in East Asia (Malaysia, Thailand and the Philippines). Secondly the considerable size of the Chinese and Indian companies result in the relevant minimum size threshold being pushed up. In EMEA and the Americas, the companies were more evenly distributed in size terms.

Finally, a number of recent social, political and economic events highlight the challenges faced in the introductory section of this article. In the past few months we have experienced Russian involvement in Georgia, violent riots in South Africa, continuing questions over China's human rights situation, political unrest in Pakistan, a controversial Indian nuclear deal, problems with terrorism in many of the emerging countries - to name but a few! These types of issues ultimately affect the local markets and investor sentiment.

1We used weighted average GDP figures from the World Bank Organisation for the years 2003, 2004, 2005 and 2006. The years are weighted 10, 20, 30 & 40%, with the lightest weighting applied to 2003 and the heaviest to 2006. The weighted procedure dampens the effects of GDP and currency fluctuation. It is worth noting that the table does not attempt to assess the ‘invested' universe. In other words, the real estate that is of suitable investment grade, and held directly by investors .
For developing/emerging countries: 

            = Country high-quality commercial real estate value
            = Country Gross Domestic Product
            = Country Gross Domestic Product per capita
2Information taken from the EPRA Global REIT Survey - August 2007. Available from
3Property Fund for Public Offering (PFPO)
4Property Unit Trust (PUT)
5Fundo de Investimento Imobiliario (FII)
6Fondos de Inversion Inmobiliario (Real Estate Investment Funds)
7Free float market cap refers to the proportion of the company that available for the market to invest coverage of ftse epra/nareit global emerging market index