Emerging markets worth a look

If you haven't invested in the fast-growing economies of developing nations, you might miss out on a great opportunity

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This time is different. It’s a well-trodden trope in the investment business — be it regarding an imminent market crash, or the next to-the-moon investment.

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Opinion

Hey there, time traveller!
This article was published 24/07/2021 (503 days ago), so information in it may no longer be current.

This time is different. It’s a well-trodden trope in the investment business — be it regarding an imminent market crash, or the next to-the-moon investment.

Emerging markets (EMs) have largely fit in the latter category.

For more than two decades, investment experts have been talking about how developing economies — like China, India, Indonesia, Brazil and Thailand to name a few — are going to grow like weeds.

Wagner Magni / FreeImages

In turn, companies listed on their stock exchanges will reward intrepid investors.

All of this is partially true so far, say investment advisers and fund managers.

Yes, these economies have posted annual gross domestic product (GDP) growth upwards of six per cent in the past 20 years. By comparison, three per cent annual GDP growth in Canada would be considered a great year.

But emerging market returns — the collective growth of these nation’s publicly traded companies — have been less compelling.

Consider the MSCI Emerging Markets Index has returned about four per cent annually over the last decade. By comparison, the U.S.’s S&P 500 Index has returned almost 15 per cent per year over the same space.

In case you’re wondering, the S&P TSX Composite Index posted about 4.75 per cent. Indeed, one reason for the remarkably similar performance to EMs is both markets have largely been driven in the past by the companies involved in resources and commodities, says Chris Heakes, portfolio manager with BMO Global Asset Management, who co-manages BMO’s emerging market funds.

“(Emerging markets) were very similar to the Canadian market.” As such, investing in these geographies didn’t offer much diversification.

Yet much has changed in the last few years. This time may indeed be different, as China, India, South Korea and other EM nations have featured more listed companies involved in consumer staples and discretionary, technology and financials.

“China has grown so drastically, it’s an exposure you can’t ignore, or want to ignore,” Heakes says.

Its middle class, for instance, grew from already sizable 39 million in 2000 to about 707 million in 2018.

And the growth potential is massive in the next two decades.

“With respect to 15-year plus trends… EMs… have a lot of attractive characteristics,” Heakes says.

“You’re seeing EM countries that have four to five per cent GDP growth through COVID, and developed markets were tracking around one per cent.”

The World Bank recently published reports on economic growth, noting developing nations’ economies are going to be held back by a slow rollout of vaccines and rise in cases of increasingly infectious variants of COVID-19. Still GDP growth is forecast at 6.8 in South Asia and more than five per cent in Asia Pacific by 2022. Growth will be less robust in other EM regions, yet still on pace or slightly stronger than developed economies.

Growth potential aside, it’s simply prudent investment management to have an allocation to EMs, says Alan Fustey, Winnipeg portfolio manager with Adaptive ETF, a division of Bellwether Investment Management.

“EMs offer important diversification benefits from that of developed markets,” he says.

These nations — which include Argentina, Czech Republic, Egypt, Greece, Turkey, Taiwan, Russia, the Philippines and Saudi Arabia — make up about 11 per cent of all world equity markets.

As such, a similar allocation in the portfolio makes sense, Fustey notes.

Adding to this is the fact EM combined GDP accounts for about 43 per cent of global GDP, up from about 24 per cent 20 years ago.

Arguably, their stock and bond markets have more room to grow to reflect their growing GDP output.

Winnipeg certified financial planner Chris Douglas with Manulife Securities Corporation says his clients with medium-risk and up portfolios contain mutual funds with “a go-anywhere mandate,” and often have EM exposure. But he leaves it to the mutual fund managers to decide what the allocation should be.

Other investment advisers — speaking off the record — note China and India offer most of the growth promise right now, but for environmental, social and governance (ESG) investors, these nations — along with other EM countries — present challenges. That’s especially the case for China, regarding its human rights record.

For those wanting to up EM content, Fustey says exchange-traded funds (ETF) offer the good exposure to EMs because of their low fees and diversification. Although some argue China-only or India-only funds may be the best way to invest because they are the dominant economies in EMs, the strategy leaves out other nations like Taiwan — one of the largest producers of superconductors in the world, a key component in technology, he notes.

As such Fustey notes funds like BMO’s MSCI Emerging Markets Index ETF (ZEM), with a 0.27 per cent management expense ratio (MER), provide diversified exposure to large and mid-sized corporations in 26 nations, including China. It has average about six per cent per year over the last decade, and 29 per cent in 2020.

Another is Vanguard’s FTSE Emerging Markets ETF (VWO). Although traded in New York, its MER is just 0.1 and even includes more than 5,000 small-, medium- and large-size firms. Its 10-year annualized return is almost four per cent, but it gained 40 per cent in 2020. By comparison, the TSX Composite returned about 7.5 per cent while the S&P 500 in the U.S. grew by 18 per cent.

Regardless of choice, Heakes says EMs — despite their stellar performance last year — remain undervalued relative to the U.S. and arguably have more room to grow.

“If you’re looking at where the growth is going to come from in the world, it’s likely going to be from emerging markets.”

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