In 2016 I wrote about the outflows from the UK and Europe of Global Investors and the buying opportunities within the UK and Europe following Brexit. Our portfolios have been re-positioned to take advantage of the tactical opportunity and our clients have benefited from the adjustments made throughout 2017, leading to outperformance of the portfolios we manage on behalf of our clients. My instincts are telling me that including some focused emerging market exposure moving forward could result in further outperformance for the future.
Let’s consider first what an “emerging market” is. An emerging market, sometimes known as an emerging economy, is a country that has some characteristics of a developed market, but does not meet the standards to be considered a developed market such as the United States, Western Europe, and Japan. You may also come across the term “frontier market” which is used for developing countries with slower economies than “emerging”. Emerging markets are nations that are moving away from their traditional economies that have relied on agriculture and the export of raw materials, with their leaders wanting to create a better quality of life for their people.
In total 23 countries are considered to be emerging markets, the big 10 countries (in alphabetical order) are Argentina, Brazil, China, India, Indonesia, Mexico, Poland, South Africa, South Korea and Turkey. The main emerging market powerhouses are China and India, these two countries are home to 40% of the world’s labour force and population.
How Emerging Markets (EM) have performed compared to developed markets in 2017
Emerging markets have continued to grow faster than developed markets and produced higher returns this year, many analysts believe we’re at the beginning of a turning point in the cycle where this asset class is outperforming.
If you’ve been a long-term holder in emerging markets, this year’s gains have felt like they were a long time coming. Total returns in emerging markets from 2008 to 2016 were minus 16%. In that same time, the S&P 500 was up almost 85%. But prior to rallying double digits in 2016, emerging-market stocks were in negative territory in four out of five years beginning in 2011.
So, why might now be a good time to invest?
The index is still about 17 percent below its peak in the fall of 2007. Emerging markets remain an attractive asset class because of their relatively higher growth prospects compared with developed markets, but investors need to understand how things generally work in developing countries before investing.
Emerging markets are highly volatile
From the start of the MSCI EM Index in 1988, 76% of all annual calendar returns have been double-digit gains or losses. In that same period, the volatility (the amount by which the price varies up or down) of emerging-market stocks has been double that of their US counterparts. So it’s safe to say that emerging markets offer higher highs and lower lows than more mature markets.
These countries have unique commercial environments and may be limited in terms of reliable data and transparency, making investment into emerging markets climb up the risk scale. Emerging markets are also more susceptible to natural disasters and currency swings, such as the USD, and commodity swings, such as oil and food, as they don’t have the power to influence these movements.
Diversification and time invested matters
Geographical and sector diversification is crucial, as is investing in areas with low correlation. For instance, when US stocks (the S&P) struggle, emerging market stocks are up. When EM stocks struggle, US stocks are up. From 1988 to 2016, the returns in emerging market and US stocks were almost identical, as both gave investors gains of slightly more than 10% per year.
The chart shows the difference in returns (correlation) over different periods of each asset class. Interestingly, a mix of 80% US and 20% EM over the same period (rebalanced each year) provided a return of 11% per year.
So would a portfolio mix of US stocks and EM stocks provide sufficient diversification?
Absolutely not, other factors should be taken into consideration, which is why it’s important to ensure that your Financial Adviser is appropriately qualified to offer expert investment advice.
Investing in Emerging Markets
Investment in an emerging market fund will give you exposure to emerging markets through a Fund Manager who aims to outperform the index. That saves you time, so you don’t have to research foreign companies and economic policies. It also reduces risk by diversifying your investment into a basket of emerging markets instead of just one.
U.S. stocks have had a great run since the financial crisis ended in 2009. Emerging markets have badly lagged in that time. Clearly one good year does not make for a trend, but valuations and performance momentum places attention on emerging market stocks and attract inflows to the sector. Analysts believe there’s a good chance we’re at the beginning of a turning point in the cycle that could see emerging-market stocks outperform developed markets for years to come.
Emerging markets are not for the faint hearted, but for larger portfolios or those with a higher appetite for risk, a small exposure to emerging markets alongside other focused tactical funds could add outperformance to a portfolio that is actively managed. My view … proceed with caution but don’t miss the bus! Always consider your pensions/investments as a whole and ensure that your portfolio is regularly reviewed and positioned to take advantage of tactical opportunities such as this. Equating it to a car … the rear view mirror is showing you what’s behind … it’s no good using your rear view mirror to review your investments when seeking outperformance moving forward!
Speed Financial Solutions are a highly qualified financial services provider on the Costa del Sol looking after clients throughout Spain and the UK. We provide a discreet and comprehensive service to individuals, our service is tailored to your needs. We seek innovative solutions for our clients and employ our skills, based on many years of experience, to apply tax legislation to our clients’ advantage. Our relationship with clients is built on trust and mutual respect. We are accessible and approachable, and ready to answer your questions, giving you the confidence you want when dealing with a sensitive issue such as discussing your pensions, investments and savings.
Our Principal, Andrea Speed, is a Fellow of the Personal Finance Society (PFS) which is the professional body for the financial planning community. The PFS is part of the Chartered Insurance Institute (CII), which is the world’s largest professional body for insurance and financial services in the world.
Fellowship is the highest qualification awarded by the CII and is universally regarded as the premier qualification. It is a major achievement in the financial industry and demonstrates the acquisition of skills and knowledge at the highest of levels.
Along with a Fellowship, Andrea is a CII Chartered Financial Planner specialising in Taxation and Trusts.
Please take a look at our website – www.speedfinancialsolutions.com for further information and contact us (Tel 951 315 271 or 951 318 529) – we are happy to discuss your own situation in more detail. One of our advisers would be pleased to spend some time with you either in your home or at our office to review your current savings, investments and pensions, so do call to make an appointment. Our Financial Review is completely free of charge and without obligation.
Andrea J Speed FPFS (DM), M.A.
Principal, Fellow and Chartered Financial Planner
Speed Financial Solutions
27 October 2017
Please note that the above does not constitute advice to invest – you should seek independent financial advice before investing.