The wisdom of investing in emerging market equities has been challenged by recent global events, including the sharp decline in China’s growth, political and economic uncertainty in Brazil and last summer’s Greek fiasco. So, are emerging market equities still a suitable core strategic asset class for investors?
Depending on one’s world view, these equities may still make sense for diversified long-term portfolios. But it is essential to take the high-growth/high-risk nature of EM assets into account when making any investment decision.
Despite their high-performance reputation, emerging markets actually underperformed traditional asset classes over the past quarter century. From 1990 to the present, the Standard & Poor’s 500 index’s annual average total return was 9.2 percent, beating the 7.9 percent return for the MSCI Emerging Markets index. Of course, there have been periods over the last 25 years when EM stocks have done very well. Nonetheless, prudent investors should think carefully before adding EM exposure to their portfolios.
Investors need to understand the inherent risks in EM exposure. Geopolitical shifts and local instability can drive sweeping changes in the economic outlook for a country or an entire region, and currency fluctuations pose another major risk.
Developed markets are hardly immune to disruptive events and down cycles, of course. Think of the collapse of Long-Term Capital Management in 1998, the bursting of the tech bubble in the early 2000s, or the Great Recession of 2008-09. But developed markets are fairly diversified and resilient, and tend to bounce back from adversity more quickly than emerging markets.
Beware of falling BRICs. The notion that global economic dynamism had shifted to the emerging markets was embodied in the “BRICs” concept, popularized by Jim O’Neill of Goldman Sachs in 2001. The tremendous growth in the economic power of China in particular, and to a lesser extent Brazil, Russia, India and other nations such as South Africa, led the EM asset class to vastly outperform just about everything else in the mid-2000s.
Despite significant economic progress, many EM “growth engines” now seem to be running out of fuel. Brazil and Russia are experiencing sharp reversals, South Africa and Turkey are struggling to find a path back to prosperity, and China’s troubles are well-documented. These and other challenges are reflected in the uninspired performance of EM equities since 2010.
That said, emerging markets cannot be completely dismissed as a strategic asset class. Many emerging markets are more stable today, due to economic and financial system reforms, strengthened foreign exchange reserves, or better management of debt. A number of countries are substantially wealthier than they were in the 1990s, and are making investments in infrastructure to support more sustainable economic progress and better lives for their citizens.
Emerging markets are not created equal. India, for example, is a vastly different market from Southeast Asian countries, with different prospects and risks. This matters because indexing emerging markets is trickier than indexing something like the S&P 500. Within an EM index are multiple country exposures, and one should understand the inherent risks.
We recommend a broad EM exposure versus a targeted bet on a particular region or country. This can be accomplished through exchange-traded funds that track emerging market equities, such as the iShares MSCI Emerging Markets Mini Vol (ticker: EEMV), iShares Core MSCI Emerging Markets (IEMG), or SPDR S&P Emerging Markets (GMM). Such ETFs offer exposure to potential EM growth, while allowing investors to spread risks across a range of markets and companies.
Ultimately, deciding whether to invest in emerging markets depends on one’s view of global growth. If economies grow and consumerism spreads, EM investors have an opportunity to share in that growth. We think expectations of EM growth near 10 percent are unreasonable, and are not supported by the evidence of the last 25 years.
Yet, there are profits to be had in new markets. Even if China’s growth slows to 4 percent, that is still better than much of the developed world. EM demand is still driving growth at many global companies: Nike (NKE) reported 20 percent sales growth in China last quarter.
Investors who believe in world growth can position their portfolios accordingly — by taking a long-term strategic approach to EM allocation, understanding the high-risk/high-return nature of the class, and making smart, broadly diversified EM bets.
As of this writing, MV Financial owns and uses EEMV and IEMG in client portfolios. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by MV Capital Management, Inc.), or any non-investment related content, made reference to directly or indirectly in this article will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from MV Capital Management, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. MV Capital Management, Inc. is neither a law firm nor a certified public accounting firm and no portion of the article content should be construed as legal or accounting advice. A copy of the MV Capital Management, Inc.’s current written disclosure statement discussing our advisory services and fees is available upon request.
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Mapping Out an Emerging Market Investment Strategy originally appeared on usnews.com
