We share our view on Emerging Markets.
What does the future hold for Emerging Markets?
Emerging market performance has been in the doldrums for near on a decade now relative to developed markets and particularly the US. More recently globalism, which supported the rise of global supply chains, shifting manufacturing to emerging economies, now faces the challenge of nationalism and protectionism. Meanwhile the fall of high commodity prices after a decade of anaemic global growth has seen demand across the asset class dive.
The muted performance of emerging markets may not be that obvious to all because 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 equity 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 US 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 [a symptom of rates being cut] will increase risk taking. The importance of the response from US policy is high as it will likely 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.
The need for diversification
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.
It’s also worth noting that the risks are not evenly shared across the regions; 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.
Emerging Market investment ideas
Below are some ideas across various investment types that you may find suitable if you are thinking of adding or topping up your emerging market exposure.
Emerging market bonds
Emerging market equities
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.