Emerging markets make no sense
After poor performances over the past three years, which led to large outflows, emerging-market (EM) assets are finding their way back into institutional portfolios. Several facts make a compelling case for allocating, or re-allocating, to EMs. From a valuation perspective, EM equities are more attractive than their developed-market counterparts. The same applies to EM debt assets, which are providing a better yield than developed-market debt assets.
Many believe EM assets, in general, price economic fundamentals better than developed-market ones. EM countries, on average, should see higher rates of economic growth than the rest of the world, although the pace is slowing down. Better prospects for EMs are reflected in this year’s performance: the MSCI Emerging Markets index, an equity index, is up by more than 30% since January, and most EM debt indices have also performed well.
Many investors are therefore rebuilding their EM portfolios, looking for yield and diversification. But does it make sense to see EMs as a separate asset class?
It is true a set of ‘emerging’ and ‘frontier’ countries can be identified based on certain economic features. These include income per head, past and current growth rates, a heavier emphasis on investment than consumption, and, more generally, a changing business climate that tends towards openness.
However, the emerging world is so broad, and consists of so many different growth stories that it seems highly simplistic to see it as separate from the rest of the world. Furthermore, the economic fate of EM countries is increasingly linked to that of Western countries, and the connection is bound to grow stronger, even under the current threat of increased protectionism. EM economies depend on Western ones to the same extent that the global economy is susceptible to shifts in the Chinese economy. In practical terms, the world is essentially a continuum from an economic point of view.
Over the years, asset managers have developed expertise in EMs. But this could amount to nothing more than a deeper knowledge of local companies and economic challenges. The line between EMs and the rest of the world is blurring; companies based outside of Europe and the US are becoming more globalised.
What should matter to investors is which countries and companies are likely to take advantage of the current long-term trends. These include digitalisation, ageing and the rise of a different kind of consumer, not just in EMs but globally.
Rather than seeking diversification through an explicit allocation to a riskier, albeit theoretically more attractive, location for investments, investors should focus on long-term trends.