Sheridan Admans, our Investment Manager shares his views on Emerging Markets.
How emerging markets can help unlock returns
Over the last 20 years, on a cumulative basis, emerging markets have notably outperformed the S&P 500. However, if we look back 10 years and use the Great Financial Crisis (GFC) as the starting point, investors in a benchmark emerging market index fund would be relatively, and significantly, worse off. Over that time the S&P 500 outperformed the MSCI Emerging Market index by c.260%.
What has been the main cause of this outperformance? The likely outperformance of US equities since the GFC is in the fact the FED targeted risk taking on the part of investors by diminishing the pool of risk-free assets with its quantitative easing programme. US valuations rose significantly over the period, to a point where they now look expensive on a relative basis against emerging market equities. Another more recent challenge is the threat to globalisation hitting emerging markets. Slowing growth in China is also creating headwinds.
Negative sentiment has taken hold in emerging markets but changes to central bank policy in 2019, plus the deafening call from Donald Trump to weaken the dollar, could see emerging market assets outperform ahead, supported by emerging markets tempting a 31% discount to the MSCI World index.
US policy on an economy that’s losing momentum will focus investor’s attentions as the hunt for yield will increase risk taking. The importance of the response from US policy is high as it will impact the US dollar. If the theory holds, cutting interest rates should weaken the dollar which should encourage foreign investors to buy higher-yielding assets denominated in currencies other than the dollar.
Emerging markets remain an attractive asset class due to their potential higher growth prospect relative to developed markets. While emerging markets are looking at a Lost Decade, their ability to deliver superior returns over developed markets should not be overlooked. After all, the S&P 500 Lost Decade prior to the GFC, if overlooked, would have cost investors dearly since the crisis. This highlights the need for diversification in an investor’s portfolio; a mix of developed and emerging assets, while rebalancing them annually, could prove more beneficial to returns over time than attempting to time when to leap.
For now, dollar strength will only act as a headwind to capital flows for emerging markets that are reliant on foreign investment. It can also make the servicing of dollar-denominated debt more challenging.
The risks are not evenly shared across the regions however; there are economies that are net importers of raw materials and those that are net exporters, those that have the majority of the debt denominated in US dollars and those that don’t. These variables in themselves can have a significant impact on returns year-to-year. So picking a manager that can be nimble across a broad basket of emerging economies could be better at unlocking returns given these factors.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.