Failing to emerge

Why have China, India and other up-and-coming nations yet to transform their promise into profits?


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Emerging markets have generated buzz among investors for more than two decades. And many forward-thinking arm-chair capitalists have jumped on the bandwagon, believing the fast-growing economies of these highly populated nations would eventually be the place for equally fast-growing profits in their portfolios.

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Hey there, time traveller!
This article was published 23/04/2016 (2420 days ago), so information in it may no longer be current.

Emerging markets have generated buzz among investors for more than two decades. And many forward-thinking arm-chair capitalists have jumped on the bandwagon, believing the fast-growing economies of these highly populated nations would eventually be the place for equally fast-growing profits in their portfolios.

Yet anyone with money immersed in China, India, Brazil, Russia and Indonesia — the list could go on — has yet to see that investment outperform the old economies and, more importantly, stock markets of the developed world — especially the U.S.

Over the last decade (ending March 31) the MSCI Emerging Market Index — the basket of largest companies traded in developing markets — has provided an average annual return of just 3.34 per cent. And in the last five years, it’s averaged -3.8 per cent

Mark Schiefelbein / The Associated Press files

By contrast, the MSCI World — a collection of the planet’s largest capitalized publicly traded companies — has returned 4.86 per cent and 7.12 per cent, respectively.

The U.S. market has been even better at 7.03 per cent over 10 years and 11.44 per cent over five years.

Moreover, the experience for many average investors has often been even more negative because they generally invest after emerging markets (EMs) have had a year or two of high double-digit percentage returns, only to fall almost equally (or more) in value the following year.

All this has left many asking whether potential return is worth the risk.

“These are not for the faint of heart, and they’re not really for most people, which is unfortunate in some ways because they could turn out to be a good asset class to hold in a portfolio if you have the stomach for it,” says certified financial planner Uri Kraut, an investment adviser with Credential Securities and Assiniboine Financial Group in Winnipeg.

“It’s hard to believe that the ‘rise of the rest’ won’t continue, but you have to keep in mind that you’re buying the most volatile product out there in an era already punctuated by high levels of volatility.”

Even investment professionals whose job is finding opportunities in EMs admit the investing experience — particularly in the last few years — has yet to reflect the rapid economic growth.

“It’s the biggest issue I hear,” says Christine Tan, chief investment officer with Excel Funds in Mississauga, referring to concerns from clients regarding why emerging markets have failed to… well… emerge.

“Clients will say EMs have been fast-growing for 20 years now, but their (stock and bond) markets have not necessarily reflected that growth.”

The reasons behind this are many. Among them is these rapidly expanding economies are going through tremendous change in a few years as opposed to several decades, as was the case with developed ones like western Europe, Japan, the U.S. and Canada. And growing pains have ensued for many of these markets.

Fast growth often brings high inflation and overexpansion. Moreover, EM equity and bond markets are not well-established, which leads to mis-pricing of assets, poor liquidity, a lot of speculation and high volatility. And as their economies surge, these nations often are faced with massive social and political change — that in turn affects how their economies grow.

China, for example, has gone from a maker of products for the world to one now wanting to produce for its own population. And this has led to it re-orienting its economy, which involves slower growth. Albeit its growth at more than six per cent annually is still faster than the GDP growth of developed economies, often at less than three per cent.

But China’s economy was growing at more than 10 per cent only a few years ago. So its economy has caught a bit of a cold, and when the dragon of the emerging markets gets the sniffles, so does everyone else.

“China does not only represent a quarter of the MSCI benchmark index for emerging markets,” says Louis Lau, a director of investments for Brandes Investment Partners in San Diego.

It is also the largest consumer of raw resources in the world, he adds.

“More than 50 per cent of global demand for commodities came from China over the last 10 years.”

Until recently, its demand has driven the economies of commodity-rich developed nations such as Canada. But Canada’s economy is now suffering as China’s demand slackens.

The impact is felt even more in emerging markets such as Brazil and Russia that have economies based on resource extraction.

“China’s demand had lifted growth for many of the emerging market countries,” Lau says.

The main reason for the fall-off in demand today is China is shifting its focus from building infrastructure to an economy based more services and goods for its own people.

“The big game-changer back in 2012 is a new government came into power in China, and it said ‘We are transitioning China’s growth away from fixed assets toward more consumption,’” Tan says.

Current and past challenges aside, emerging markets remain fertile ground for long-term investors. And the recent battering they’ve endured may represent an entry point.

“There has been a lot of negative sentiment toward emerging markets,” says Michael Greenberg, portfolio manager at Franklin Templeton Solutions.

“That’s actually when you want to consider getting back in again.”

Of course, plenty of risks remain, including currency volatility — which has wreaked havoc on emerging markets recently. For example, the rise of the U.S. dollar has put pressure on EM companies, which have borrowed in U.S. dollars to expand operations to serve growing domestic and export demand.

“The problem is they’re still earning revenue in their local currency, so if the value of the U.S. dollar increases, their ability to service debt goes down because they need more profits to convert back into U.S. dollars,” Greenberg says.

Yet the problems of today — like the past ones — will likely pass, Lau says.

“So the long-term story is very much intact.”

While much of the upside of their economies has yet to translate into commensurate stock market performance, this may soon change as EMs’ equity and bond markets mature. Just as important, their middle classes are growing quickly, transforming their economies into ones much like ours, driven by domestic consumption — only larger.

“When I started in the 1990s, emerging markets were very dependent on our part of the world,” Tan says. “They were immature economies and much smaller when measured by GDP, but that complexion of growth is rapidly changing.”


Updated on Saturday, April 23, 2016 9:02 AM CDT: Photo added.

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