EIDO - EIDO: A China Reopening Beneficiary

Summary

• The iShares MSCI Indonesia ETF offers investors low cost, albeit concentrated exposure to Indonesian equities.
• While the distribution yield isn't high, the growth potential of Indonesian equities far outweighs the income factor.
• In the near term, the reopening of the Chinese economy, a major trading partner, should drive higher earnings revisions.

Indonesian equities have suffered foreign outflows this year, weighing on the YTD performance of the iShares MSCI Indonesia ETF ( EIDO ). Understandably, the appeal of Chinese equities post-reopening has played a part from a rotational trade perspective; fundamentally, though, Indonesia's economy also stands to benefit from China's reopening. While the multi-year, COVID-driven lockdowns weighed on the trade balance with China, the reopening has already seen Indonesia-China trade revert to surplus territory. And as China's reopening continues to gain momentum alongside increased economic activity, expect exports to China to rise in tandem, boosting the EIDO portfolio. Also boosting the outlook for equity valuations is the dovish commentary by Bank Indonesia ('BI' or the Indonesian central bank) at its recent policy meeting, while support from BI intervention should cushion any FX downside.

Fund Overview - A Low-Cost, Concentrated Vehicle for Indonesian Exposure

The US-listed iShares MSCI Indonesia ETF seeks to track, before fees and expenses, the performance of the MSCI Indonesia IMI 25/50 Index, a market cap-weighted index comprising the large, mid, and small-cap segments of the Indonesia equity market or ~99% of the Indonesian free float-adjusted market cap. The ETF held $449m of net assets at the time of writing and charged a 0.58% expense ratio, making it one of the more cost-effective options available to US investors looking to express a single-country view on Indonesia. A summary of key facts about the ETF is listed in the graphic below:

In line with similar Southeast Asian ETFs, the fund's sector allocation is heavily concentrated on the financial sector at 45.9% - by comparison, the iShares MSCI Malaysia ETF ( EWM ) also has a >40% allocation. The rest of the portfolio comprises consumer staples (11.5%), materials (10.8%), communication (9.8%), and energy (7.2%). On a cumulative basis, the top five sectors accounted for ~85% of the total portfolio.

The fund is spread out across 88 holdings. Indonesia's leading private banks make up the largest two single-stock holdings, namely PT Bank Central Asia Tbk ( PBCRF ) at 19.7% and PT Bank Rakyat Indonesia Tbk ( BKRKY ) at 12.8%. The ETF also has outsized holdings in telco PT Telkom Indonesia ( TLK ) at 7.3%, PT Bank Mandiri Tbk ( PPERF ) at 6.2%, and Indonesian conglomerate Astra International ( PTAIF ) at 3.7%. The top five holdings account for ~49% of the overall portfolio, so despite being spread out over more stocks vs. comparable Southeast Asian ETFs, this ETF remains fairly concentrated.

On a YTD basis, the ETF has appreciated by 2.8% but has compounded at an unremarkable 1.1% pace (in market price and NAV terms) since its inception in 2010. The performance is, however, broadly in line with comparable Southeast Asian ETFs like the iShares MSCI Philippines ETF ( EPHE ) and the iShares MSCI Malaysia ETF over a similar time frame. The fund distribution runs on a semi-annual basis, with the trailing twelve-month yield at 2.4% - a surprisingly low distribution yield given the concentration on highly cash-generative banking names.

Export-Driven Tailwind vs. Subsidy Headwind

While foreign flows will likely be concentrated on China following its post-COVID reopening, Indonesia's economy and markets remain fundamentally strong. Along with the rest of the Southeast Asian region, the country stands to benefit from the re-shoring of industries outside of China (for geopolitical and economic reasons), as well as a further increase in exports to China as its economy regains momentum. In particular, key commodities such as iron, steel, and crude palm oil will be key to watch, given they have traditionally contributed a large share of Indonesia's exports to China. With the EIDO portfolio maintaining an outsized exposure to materials (third-largest sector allocation), ETF investors stand to benefit directly. The second-order impact of a pick-up in exports to China should also filter through to the rest of the portfolio, particularly the banks, which tend to track overall economic activity.

On the other hand, an increase in subsidized fuel prices ( announced in September last year) will weigh on consumers' purchasing power. Recall that the government had announced a 30% hike in diesel and RON 90 prices, with the RON 92 price also increasing by 16%. That said, the government's decision to reallocate savings from the subsidy cut to financial assistance (e.g., wage subsidies and cash assistance) for lower-income groups should help to cushion the economic impact. Plus, fuel prices, even after the latest adjustment, remain heavily subsidized, so I expect the benefit from a China-led export recovery will outweigh any transitory consumer weakness. EIDO's focus on the more defensive consumer staples (vs. discretionary) should insulate against the downside as well.

A China Reopening Beneficiary

The relative post-COVID outperformance in Indonesian equities has fizzled out in recent months amid the China reopening. While this technical shift makes sense from a rotational trade perspective, Indonesia remains fundamentally strong and, perhaps most importantly, an economy levered to China's reopening. In line with the trade surplus Indonesia has historically run, the impact of the COVID restrictions in China looks poised to reverse in the coming months as the reopening gathers steam. And given EIDO's concentration on the major banks, which tend to track economic activity, a corresponding boost from higher exports to China should also boost the ETF performance. Alongside support from BI on the FX side and the pending pause in rate hikes, EIDO remains a great low-cost vehicle to gain emerging market growth exposure.

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