The post-tax season, after most investors have reviewed their portfolios, is a good time to explore investment options they may not have considered before.
One idea for those who value potential growth more than stable principal value is emerging markets. These are a group of developing countries that are becoming more advanced and have the following characteristics:
< Higher gross domestic product rate.
< Lower level of debt.
< Improving standard of living.
< Superior demographic.
< Capital market infrastructure.
< Market exchange with regulatory oversight.
About 23 countries, including India, China and Chile, meet such standards, according to the International Monetary Fund, Standard & Poor’s and other organizations.
WHY NOW
Investors who have never considered emerging markets before may be surprised to learn that in 2016, for the first time in several years, emerging markets outperformed their developed market (countries such as the U.S. and Europe) counterparts.
As of late March, the MSCI (formerly Morgan Stanley Capital International) Emerging Markets Index returned 12.64 percent in U.S. dollar terms, while the MSCI All Country World Index returned 6.52 percent.
This means that after several years of underperformance, there are some signs of positive trend changes for emerging markets.
FAST PACE OF GROWTH
Since the U.S. elections in 2016, the global rally in risk assets has reflected optimism about aggressive fiscal policies from the United States.
Accelerating global growth has been particularly important in the emerging world.
Emerging market economies are expected to grow at their fastest pace in almost three years, driven by Brazil, Russia and China.
Although oil prices have recently seen a pullback, commodity prices generally have remained stable, supporting the emerging market economies that rely on them for expansion.
INCREASINGLY ATTRACTIVE OPTION
The global recession of 2008 weeded out weaker companies throughout the world. In developed countries, this resulted in markets that have gone up somewhat in relative value, but not significantly.
In fact, developed markets today are highly leveraged and have an older and smaller working population. These factors suggest less opportunity for growth.
Emerging markets also experienced belt tightening caused by the global recession, but this austerity resulted in stronger balance sheets and better efficiencies.
Therefore, the case for emerging markets, with their superior demographics, lower debt levels and potential for productivity improvement, remains as strong as ever.
And a wide relative valuation discount for emerging markets versus developed markets will make emerging markets an increasingly attractive investment over the coming years.
CAVEATS
Emerging markets do present some risks and variables that need to be actively managed by professional advisers. They include:
< While they have strengthening financial systems, some emerging market countries remain vulnerable to corruption and weak regulatory oversight.
< Emerging markets could be affected by developed countries’ apparent move toward populism and protectionism. This could hamper trade and global growth.
< The rise of commodity prices could slow, which could have a negative effect on emerging markets.
< The U.S. dollar could continue to strengthen, which would make emerging markets investments less desirable.
UNDERINVESTED GLOBALLY
Also, to become more involved in emerging markets, investors may need to resist “home-country bias.”
This is a tendency of investors to place a heavier emphasis on assets in their country of domicile than on global assets.
It is interesting to compare the ratios between the U.S. as a percent of global GDP and value of U.S. stocks and bonds as a percentage of global capital markets.
The U.S. share in global GDP proportion is much smaller compared to the average U.S. investor’s allocation to U.S. assets. This suggests that U.S. investors may be underinvested in international assets.
TIME TO POUNCE?
The bottom line is that emerging markets may not be right for investors who are focused primarily on preserving principal and generating current income.
But for those who want to diversify geographically and take advantage of growth in economies that are becoming more stable, now may be the time to consider emerging markets.
Chris Kim is chief investment officer of Tompkins Financial Advisors, based in Wyomissing. He is responsible for the administration and management of the company’s multibillion dollar wealth management portfolios and overall client investment program. He can be reached at [email protected]
