• Skip to main content
  • Skip to secondary menu
  • Skip to primary sidebar
  • Skip to footer

Optimized Portfolio

Investing and Personal Finance

  • Start Here
  • Investing 101
    • Beginners Start Here – 10 Steps To Start Building Wealth
    • What Is the Stock Market? How It Works & How to Invest in It
    • How To Invest in an Index Fund – The Best Index Funds
    • Portfolio Asset Allocation by Age
    • How To Invest Your Emergency Fund
    • Portfolio Diversification – How To Diversify Your Portfolio
    • Dollar Cost Averaging vs. Lump Sum Investing (DCA vs. LSI)
    • How To Invest Your HSA (Health Savings Account)
    • Factor Investing and Factor ETFs – The Ultimate Guide
    • more…
  • Lazy Portfolios
    • All Weather Portfolio
    • Bogleheads 3 Fund Portfolio
    • HEDGEFUNDIE’s Excellent Adventure
    • Warren Buffett Portfolio
    • Golden Butterfly Portfolio
    • Paul Merriman Ultimate Buy and Hold Portfolio
    • Ben Felix Model Portfolio
    • Permanent Portfolio
    • David Swensen Portfolio
    • 60/40 Portfolio
    • more…
  • Funds
    • VOO vs. VTI – Vanguard S&P 500 or Total Stock Market ETF?
    • The 7 Best International ETFs
    • The 8 Best Small Cap ETFs (4 From Vanguard)
    • The 5 Best REIT ETFs
    • The 5 Best EV ETFs – Electric Vehicles ETFs
    • VIG vs. VYM – Comparing Vanguard’s 2 Popular Dividend ETF’s
    • The Best Vanguard Dividend Funds – 4 Popular ETFs
    • The 5 Best Tech ETFs
    • The 7 Best Small Cap Value ETFs
    • The 6 Best ETFs for Taxable Accounts
    • The 5 Best Emerging Markets ETFs (1 From Vanguard) for 2023
    • more…
  • Leverage
    • What Is a Leveraged ETF and How Do They Work?
    • How To Beat the Market Using Leverage and Index Investing
    • The 9 Best Leveraged ETFs
    • Hedgefundie’s Excellent Adventure
    • Leveraged All Weather Portfolio
    • Leveraged Permanent Portfolio
    • Leveraged Golden Butterfly Portfolio
    • NTSX – Review and Summary
    • TQQQ – Is It A Good Investment?
    • PSLDX – A Review
    • SWAN – A Review
    • RPAR Risk Parity ETF Review
    • more…
  • Dividends
    • The Best M1 Finance Dividend Pie
    • The 11 Best Dividend ETFs
    • The Best Vanguard Dividend Funds – 4 Popular ETFs
    • VIG vs. VYM – Comparing Vanguard’s 2 Popular Dividend ETF’s
    • 8 Reasons Why I’m Not a Dividend Income Investor
    • QYLD – A Harsh Review
    • more…
  • Brokers
    • The 5 Best Stock Brokers
    • The 4 Best Investing Apps
    • M1 Finance Review
    • Brokers with the Lowest Margin Rates
    • M1 Finance vs. Fidelity
    • M1 Finance vs. Vanguard
    • Webull vs. Robinhood
    • Stash vs. Robinhood
    • M1 Borrow Review (How M1’s Margin Loan Works)
    • more…
  • Retirement
    • The 10 Best ETFs for Retirement Portfolios in 2023
    • The 4% Rule for Retirement Withdrawal Rate – A Revisitation
    • Sequence of Return Risk in Retirement Explained
    • Traditional IRA Explained
    • Roth IRA Explained
    • 401k vs. Roth IRA
    • Roth IRA vs. Traditional IRA
    • Backdoor Roth IRA Explained
    • more…
  • My Toolbox

Should You Avoid State-Owned Enterprises in Your Portfolio?

Last Updated: March 22, 2022 2 Comments – 5 min. read

State-owned enterprises typically have inherently lower operating efficiency due to compromised business interests. It may be prudent to avoid them in your international portfolio. Here we'll see what the data has to say.

Disclosure:  Some of the links on this page are referral links. At no additional cost to you, if you choose to make a purchase or sign up for a service after clicking through those links, I may receive a small commission. This allows me to continue producing high-quality, ad-free content on this site and pays for the occasional cup of coffee. I have first-hand experience with every product or service I recommend, and I recommend them because I genuinely believe they are useful, not because of the commission I get if you decide to purchase through my links. Read more here.

Contents

  • What Are State-Owned Enterprises?
  • Advantages of SOEs
  • Disadvantages and Risks of SOEs
  • State-Owned Enterprises – Fundamentals and Performance Data
  • Avoiding SOEs in Your Portfolio
  • Conclusion

What Are State-Owned Enterprises?

State-owned enterprises, or SOEs, refer to companies with at least partial government ownership. The relevant financial products typically define an SOE as having greater than 20% government ownership, but an SOE could really have 1% government ownership or 100% government ownership. Often, the state has a controlling share of an SOE, though this isn't always the case.

SOEs aren't really prevalent in free economies like the United States, where publicly traded companies are largely free to operate as they wish without government intervention, though we do still have government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac.

SOEs are much more common in Emerging Markets like China. Most SOEs are remnants of communist regimes that have now embraced capitalism. Naturally, SOEs are typically involved with energy, materials, financials, etc. as these comprise a country's banking system, infrastructures, and natural resources. Examples include mining companies, public transportation providers, postal services, and utilities. SOEs like these are sometimes created solely to boost the economy of a developing country, e.g. oil in Brazil.

According to the International Monetary Fund (IMF), the assets of state-owned enterprises worldwide is $45 trillion.

Advantages of SOEs

While SOEs may sound bad so far, there can be economic advantages.

Some SOEs gain the status of being a legal, government-backed monopoly, effectively eliminating any competition.

The stock returns of SOEs also tend to be more stable (less volatile), which may be desirable for some risk-averse investors.

Disadvantages and Risks of SOEs

State-owned enterprises can be propped up by government funding to prevent them from failing, particularly when they're deemed necessary to a country's infrastructure, such as the U.S. Postal Service, which has been allowed to operate at a loss for extended periods. This is particularly prevalent in China, where a free market would otherwise cause the business to fail. Even worse, individual heads of government may use the state's controlling share in a company to pursue personal goals.

This government ownership naturally leads to decreased operating efficiency, as managers are serving two opposing interests: government and shareholders. Bureaucracy and political interests are usually at odds with shareholder value maximization. Unfortunately, it is more likely that the governments' interests win out. which means lower profits.

The prevailing view is thus that these opposing interests invariably lead to lower stock returns on average, and that investors should invest in companies with their interests in mind, i.e. companies that are not SOEs.

Let's see what the empirical evidence has to say.

State-Owned Enterprises – Fundamentals and Performance Data

If the theoretical basis for lower expected returns of state-owned enterprises is sound, we would expect it to show up both in fundamental valuation metrics and in the empirical historical stock performance.

The first obvious place to look is historical returns between SOE and non-SOE firms. To show this, WisdomTree took the Emerging Markets universe and looked at cumulative returns for broad market-cap-weighted portfolios of SOEs and non-SOEs, with an SOE being firms with greater than 20% state ownership:

soe vs non-soe returns
Source: FactSet, WisdomTree
soe vs non soe annual returns
Source: WisdomTree

As. you can see, the data greatly favor non-SOEs. We would expect this performance to show up in some difference in fundamental metrics for quality and/or efficiency. And indeed it has, showing up in the difference of Return on Assets:

soe roa
Source: FactSet, MSCI, WisdomTree

Interestingly, the gap seems to be widening in recent years too.

Avoiding SOEs in Your Portfolio

So we can see why we might want to avoid SOEs, but how can we do that and remain globally diversified in stocks?

WisdomTree themselves created a first-of-its-kind fund to capture Emerging Markets while excluding SOEs, defined as firms with greater than 20% government ownership. The ticker is $XSOE. Here's how the fund has performed vs. the broader Emerging Markets index since the fund's inception in 2015:

xsoe performance
Source: PortfolioVisualizer.com

Note though that the sector exposure varies significantly between SOEs and non-SOEs in Emerging Markets:

soe sectors
Source: MSCI, WisdomTree

WisdomTree notes that “it is prudent to consider the exposure of SOEs compared to non-SOEs in the broad MSCI Emerging Markets Index. Since the end of 2007, the benchmark has seen an evolution of exposures. SOEs continue to occupy a large share of the market’s overall exposure. Worth noting is the growth of the Information Technology and Consumer sectors over this period, particularly among non-SOEs. It is no coincidence that these “new economy” sectors have been among the key drivers of broad EM returns and overall growth of the market, as some of the more traditional, “old economy” sectors, such as Energy and Financials, have lost market share and continue to be the largest sectors of SOEs.”

Investors still wanting some exposure to SOEs and the “old economy” sectors in Emerging Markets can hedge their bets by utilizing both $XSOE and a broad Emerging Markets index fund like $VWO.

Also keep in mind that with the sector weightings above, XSOE naturally tilts toward growth stocks, and Growth has performed particularly well over the backtested period. This may be desirable if the rest of your portfolio heavily tilts Value, but again it may be a good idea to still maintain some reasonable exposure to SOEs in Emerging Markets to keep those Value-oriented sectors like Utilities.

It's entirely possible that this recent outperformance was due to these different sector weightings and Growth tilt, but I still like the idea of avoiding SOEs on a fundamental basis.

Conclusion

Given the intuitive logic of decreased operational efficiency and the data, it may be prudent to avoid or at least underweight state-owned enterprises (SOEs) in one's international investment portfolio. XSOE from WisdomTree is a fund that captures Emerging Markets while selectively excluding SOEs, defined as having greater than 20% state ownership. The sector exposure of XSOE will likely differ from “traditional” Emerging Markets funds that do include SOEs, so it may be wise to keep minimal exposure to maintain sector diversification.

How do you feel about SOEs vs. non-SOEs? Let me know in the comments.


Disclosures:  I am long XSOE and VWO.

Disclaimer:  While I love diving into investing-related data and playing around with backtests, this is not financial advice, investing advice, or tax advice. The information on this website is for informational, educational, and entertainment purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. I always attempt to ensure the accuracy of information presented but that accuracy cannot be guaranteed. Do your own due diligence. All investing involves risk, including the risk of losing the money you invest. Past performance does not guarantee future results. Opinions are my own and do not represent those of other parties mentioned. Read my lengthier disclaimer here.

m1 finance get started

Don't want to do all this investing stuff yourself or feel overwhelmed? Check out my flat-fee-only fiduciary friends over at Advisor.com.

77 percent of millenials report their finances are a source of anxiety

Related Posts

  • 6 Popular Invesco ETFs for Indexing, Factors, & Income
  • Neapolitan Portfolio – A Simple Diversified 3-Asset Portfolio
  • VYM vs. HDV – Vanguard Dividend ETF vs. iShares Dividend ETF
  • 7 Best Covered Call ETFs for Income Investors in 2023
  • Webull vs. Robinhood Brokerage Comparison (2023 Review)

About John Williamson, APMA®

Analytical data nerd, investing enthusiast, fintech consultant, Boglehead, and Oxford comma advocate. I'm not a big fan of social media, but you can find me on LinkedIn and Reddit.

Reader Interactions

Comments

  1. Jon says

    March 15, 2022 at 9:37 pm

    I have been interested in this fund for a while now. I have a few questions:
    1. Could the over performance be attributed to the difference in dividends? VWO has nearly 3% whereas XSOE has around half that (according to M1 Finance app). Would this also make this fund more tax efficient than other emerging market ETFs?
    2. Your recommendation to hold some SOEs alongside this fund has me wondering if I paired this up with DGS, would that be sufficient? I’m not sure how to check the percentage of SOEs in an ETF.
    3. Would it be unwise to tax loss harvest from VWO to XSOE? I feel like because they aren’t very similar, there are more risks to doing this.

    Thanks!

    Reply
    • John Williamson says

      March 17, 2022 at 12:00 am

      1. No. Dividends don’t do anything. XSOE has beaten VWO since its inception. Not sure about tax cost; XSOE may do more trading. View the prospectuses.
      2. Not sure. You could look into each of the top holdings of DGS manually, I suppose.
      3. Depends on the goal, I guess. Definitely 2 different funds so no risk of wash sale, but still a correlation of 0.94. You’d only need to dip out of it for 30 days.

      Hope this helps, Jon.

      Reply

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Primary Sidebar

  • Facebook
  • Instagram
  • Reddit
  • Twitter
  • YouTube
  • Patreon

Join 5,372 other investors

Take control of your financial future by subscribing to receive exclusive emails with expert tips, news, and notifications of new posts and important updates.

Don't worry, I hate spam too. No ads.

John Williamson, APMA®

Analytical data nerd, investing enthusiast, fintech consultant, Boglehead, and Oxford comma advocate. I'm not a big fan of social media, but you can find me on LinkedIn and Reddit. Read More…

Most Popular

Ray Dalio All Weather Portfolio Review, ETFs, & Leverage (2023)

HEDGEFUNDIE’s Excellent Adventure (UPRO/TMF) – A Summary

Golden Butterfly Portfolio Review and M1 Finance ETF Pie

David Swensen Portfolio (Yale Model) Review and ETFs To Use

53 Lazy Portfolios and Their ETF Pies for M1 Finance (2023)

VIG vs. VYM – Vanguard’s 2 Popular Dividend ETFs (Review)

Warren Buffett ETF Portfolio (90/10) Review and ETFs (2023)

Bogleheads 3 Fund Portfolio Review and Vanguard ETFs (2023)

Paul Merriman Ultimate Buy and Hold Portfolio Review, M1 Pie (2023)

The Best M1 Finance Dividend Pie for FIRE & Income Investors

m1 sidebar

rocket money

m1 sidebar

visor sidebar

retirable

Portfolio Asset Allocation by Age – Beginners To Retirees

The 7 Best Small Cap ETFs (3 From Vanguard) for 2023

9 Best International ETFs To Buy (6 From Vanguard) in 2023

The 3 Best Inverse ETFs to Short the S&P 500 Index in 2023

Ben Felix Model Portfolio (Rational Reminder, PWL) ETFs & Review

Factor Investing and Factor ETFs – The Ultimate Guide

NTSX ETF Review – WisdomTree U.S. Efficient Core ETF (90/60)

The Ginger Ale Portfolio (My Own Portfolio) and M1 ETF Pie

TQQQ – Is It A Good Investment for a Long Term Hold Strategy?

QYLD – Avoid This ETF as a Long-Term Investment (A Review)

The 5 Best T Bill ETFs (Treasury Bills) To Park Cash in 2023

JEPI ETF Review – JPMorgan Equity Premium Income ETF

SPAXX vs. FZFXX, FDIC, FCASH, FDRXX – Fidelity Core Position

Recent Posts

“Should I Own International Stocks?” Yes. Here’s Why.

Return Stacking Explained – Greater Returns With Lower Risk?

RSSB ETF Review – Return Stacked Global Stocks & Bonds ETF

Fees, Trees, & Forests – Stop Obsessing Over Expense Ratios

Optimized Portfolio “Best in Class” ETFs List for 2023

7 Best Covered Call ETFs for Income Investors in 2023

Roth IRA vs. Traditional IRA – Which Is Better for You? (2023)

How To Build a 3 Fund Portfolio at Fidelity in 2023

Fidelity ZERO Funds Review – What’s the Catch?

Jack Bogle Was Wrong About These 3 Things

I Bonds Explained (US Savings Bonds) – Ultimate Guide (2023)

Sharpe Ratio vs. Sortino vs. Calmar – Risk Adjusted Return

Portfolio Risk Explained – How To Think About Risk and Volatility

The 10 Best ETFs for Retirement Portfolios in 2023

VOO vs. VOOV vs. VOOG – Vanguard S&P 500, Value, or Growth?

View All...

Footer

  • Facebook
  • Instagram
  • Reddit
  • Twitter
  • YouTube
  • Patreon

Amazon Affiliate Disclosure

OptimizedPortfolio.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.

Email Newsletter

Sign up to receive email updates when a new post is published.

Don't worry, I hate spam too. No ads.

About - My Toolbox - Privacy - Terms - Contact


Copyright © 2023 OptimizedPortfolio.com

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Ok, Got ItReject Read More
Privacy & Cookies Policy

Privacy Overview

This website uses cookies to improve your experience while you navigate through the website. Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website. These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience.
Necessary
Always Enabled
Necessary cookies are absolutely essential for the website to function properly. This category only includes cookies that ensures basic functionalities and security features of the website. These cookies do not store any personal information.
Non-necessary
Any cookies that may not be particularly necessary for the website to function and is used specifically to collect user personal data via analytics, ads, other embedded contents are termed as non-necessary cookies. It is mandatory to procure user consent prior to running these cookies on your website.
SAVE & ACCEPT