Over the last year, shares from global, developed markets have produced a good return for investors; many have been surprised to see that returns have been better than the interest earned from cash.
However, some people have reduced risk by diversifying their portfolios to include other asset classes. Many of these asset classes have not produced good returns and it’s fair to ask if they should continue to be part of a portfolio. Last week, we looked at fixed interest stock. This time, we consider shares from emerging markets.
Emerging markets are simply the stock markets of countries which aren’t considered to be developed. Most of these countries are located in South East Asia, with some in South America, Eastern Europe and elsewhere. If you are investing in an emerging markets fund, chances are it will include shares of companies based in China, India and Taiwan, and possibly Brazil and South Africa. Until fairly recently, there would have been some exposure to Russia too. There is some dispute about whether some countries have emerged or are emerging – FTSE classifies South Korea and Poland as developed, but MSCI considers them to be emerging. Companies like Samsung, Hyundai and LG are located in South Korea, and it is the fourth largest country in the MSCI index, so it is important to know how a fund classifies this country, before investing.
There are several reasons why we recommend emerging markets funds to our investors (incidentally, we don’t recommend them to lower risk investors). There is an expectation that companies based in emerging markets will have the potential to grow more quickly as those countries develop. China’s Alibaba is a good example of this, growing to become one of the world’s largest retailers. There are other notable success stories in the emerging world, with Taiwan Semiconductor being one of the world’s largest companies in this sector. Many of our clients have entrusted their savings to the UK operation of India’s ICICI Bank in the past.
And that potential for additional returns has been fulfilled in many years – in eight of the ten calendar years starting in 2003, shares from emerging markets produced better returns than those from developed countries. SOURCE: FINANCIAL EXPRESS ANALYTICS, using data obtained on 29th OCTOBER 2023
Emerging market companies also tend to pay dividends to return money to investors; one of the funds which we recommend to many of our clients, which tracks the MSCI index, has a yield of over 3% (this isn’t guaranteed to continue, of course).
And the other reason why we like emerging markets funds is that they don’t always move in the same direction, at the same time, as global stockmarket funds. This is technically known as a “low correlation”. The shorter the period, the lower the correlation between emerging and developed markets. This low correlation helps to reduce the risk in an investment portfolio.
However, like the boy in the Emperor’s New Clothes, some of our clients have asked why, despite all of these advantages, emerging markets funds haven’t performed well. In the last five years, returns have been relatively poor – in February 2021, emerging markets indices started to fall in value while developed markets carried on going up. The follow on question is whether our clients should continue to invest in emerging markets funds.
As for so many investment questions, a large part of the answer lies in the USA, not in the emerging markets. For much of 2021 and 2022, the Dollar strengthened against almost every currency and, since March 2022, interest rates in the USA, and elsewhere, have increased. Neither has been helpful for emerging market companies. Add in some global, and emerging country political tension and you start to see why emerging market companies have underperformed.
It is beginning to look more likely now that US interest rates will reduce, and this may lead to an improvement in the values of emerging market shares. However, the long term growth potential of emerging market companies remains attractive. Companies like Taiwan Semiconductor may continue to expand their global operations, and, like Samsung, other companies have the potential to become household names.
We do expect that emerging markets share funds will give investors a bumpy, but ultimately rewarding ride, with a different return profile than for developed funds. Politics will no doubt continue to impact emerging markets, and it won’t be a surprise if climate change affects these countries (even more than it has done already). As a result, we think it is advisable for many investors to have an allocation to this asset class, but we limit our clients’ exposure to a maximum of 10% of their portfolios. The attractive dividends also mean that we continue to recommend to clients making withdrawals from their portfolios too.
Philip Wise | philip@sussexretirement.co.uk
Managing Director and Chartered Financial Planner
