If words like volatility, uncertainty and fear spring to mind when you think of emerging markets, the speakers at Benefits Canada’s 2012 Defined Benefit Summit suggested a substitute: opportunity.
While risks still exist, the promise of today’s emerging markets—higher returns than the sleepy bond markets, the chance to invest early in economies that are growing rather than stalling—can no longer be ignored. Emerging markets may be just the antidote that plan sponsors need to cure their enthusiasm for lower-yield fixed income investments.
The tag team of Christine Girvan, managing director, and Thomas Melendez, MFS institutional equity portfolio manager with MFS McLean Budden, addressed the best ways to access emerging market equity, while Adam Borneleit, senior portfolio manager for emerging market corporate debt and head of emerging market debt research with BlueBay Asset Management LLP, examined emerging market external bonds. All three focused on teasing out the risk comparison with developed markets, which make EM look more attractive than ever.
Emerging markets have come a long way since their “lost decade” of the 1990s, said Melendez. Ironically, the changes that EM policy-makers called for in the early 2000s were similar to those being considered in the developed world today: the need for sound financial systems and low public sector indebtedness. For the developing world, making such adjustments both narrowed their wide spreads and made them less prone to crisis. Today, global growth originates more than 70% from emerging markets. Clearly, a transformation is taking place.
Think differently about investments
DB Summit photo galleryCompare and contrast
Not only are emerging markets looking good on their own, but the turmoil in developed markets is making them look good by contrast. Today, the debt-to-GDP ratio albatross in developed countries is staggering; for instance, about 107% in the U.S. and 200% in Japan. By comparison, the debt-to-GDP ratio of emerging markets is about 34%.
Comparing demographics between developed and developing countries also make emerging markets look good, said Borneleit. “In the developed world, baby boomers are hitting retirement, where they are likely to draw on their pensions and spend less. By contrast, emerging markets have a growing population of working-age people, who are spending money and building houses.”
Yet while emerging markets have recently drawn investor attention with their greater stability and growth, they have never been a terrible investment, said Girvan. She pointed out that the annual return since 1988, when the EM equity index was created, has averaged 12.5%. “So, in the 24-year period from 1988 to 2011, I would argue, as an equity investor, you’ve been paid to take that risk,” she said. However, she cautioned that investors themselves might be limiting their returns in this market. “Most investors come to emerging markets after they’ve had a two- to three-year very good run and then head for the exits as soon as there are signs of volatility.”
Open mind
Pointing out that investing in emerging markets has never been a terrible financial decision, Girvan asked potential investors to re-examine other assumptions about this asset class. One way of doing so is to consider the assets by revenue rather than location, she suggested.
Historically, analysts have based global exposures on where the companies are domiciled. For example, the MSCI World Index weights chart with 2010 figures show the numbers by domicile to feature zero emerging market content. However, when broken down by revenue, the same data show a 10% to 15% exposure (she noted the study was recently redone and showed 18% in emerging markets).
In fact, Girvan said that many investors may already have emerging markets hidden in other asset classes; for instance, an asset might be identified with a sector but upon closer inspection also happen to originate from an emerging market.
Melendez pointed out another emerging markets fallacy. “One of the biggest misconceptions relating to emerging market companies is that they’re only locally based and locally producing for local needs,” he said, citing several examples including Samsung, Taiwan Semiconductor and Cemex, the world’s third largest cement company. “There are lots of examples of companies domiciled in emerging markets that are global in nature,” said Melendez. “We have to move away from thinking of emerging markets as locally based and consumed.”
Pointing to a chart that revealed many pension funds have an average of 6.3% exposure to emerging markets, Melendez furthermore expressed confidence this number would soon explode. “Over the next three to five years, we will see dramatic change in allocation to emerging markets because the question today is no longer ‘Should I be invested in emerging markets?’ The question is ‘How much exposure should I have?’ Emerging markets have now shifted from an opportunistic asset class to a strategic asset class.”
Take time to investigate
In spite of their enthusiasm, these emerging market advocates are frank about the potential risks. Sometimes there is not a great correlation between economic growth and equity returns, said Girvan.
There is movement but still a ways to go in some corporate governance. The perception of corruption in different markets has not shown tremendous change in studies done by Transparency International, a global coalition against corruption.
Such concerns only emphasize the importance of doing your homework with respect to individual companies. Understanding business plans, strategies and management are all essential to a solid investment, said Borneleit. “You may need to meet with management, dig through financials and, ultimately, avoid companies where you don’t feel comfortable.”
For those who are willing to look at emerging markets from a different perspective, the potential for payoff is substantial, and that’s good news for those looking for burgeoning opportunities outside their comfort zone. “They’re stronger than ever before at a time when the developed world is going the other way,” said Borneleit.
Suzanne Bowness is a freelance writer based in Toronto. sue@codeword.ca