It has been a challenging few months for the markets – the S&P 500 is down about 1 per cent since January, while the S&P/TSX Composite index has fallen by 3.9 per cent – but there is one area that continues to hold up relatively well: emerging markets.
Although the MSCI Emerging Markets Index has been flat over the past four months, the asset class has climbed by 18 per cent over the past 12 months, compared with 11-per-cent and 0.6-per-cent gains for U.S. and Canadian stocks.
While emerging markets have long been thought of as a place to go for growth, in reality, these stocks have struggled. The Emerging Markets Index is down 2 per cent over the past decade, while the S&P 500 is up 90 per cent, and gains have been followed by losses as skittish global investors tend to sell stocks in what they perceive as risky countries when they’re nervous about the global economy.
Something, though, may be changing. These countries, which include Brazil, China, Russia and India, have outperformed the S&P 500 by 15 per cent over the past two years, and only declined 1 per cent more than the U.S. market during February’s dip.
According to Christine Tan, Portfolio Manager, Sun Life Global Investments, this outperformance is no fluke. Rather, it may be a sign of good things to come for investors who are willing to put some of their money into this diverse asset class.
A more mature market
One key reason emerging markets have been doing well is that they have matured, says Ms. Tan. Their stock markets, corporate governance standards, central banking practices and governments have developed over the past two decades – though they still have some growing to do.
“I sometimes refer to emerging markets as entering their teenage years,” she says.
It has helped that hundreds of millions of people have moved out of poverty and into the middle class, creating a domestic demand for consumer goods in the process. Now, China is the second-largest economy in the world behind the U.S., while others, such as South Korea, India and Brazil are also growing into sizable economies.
“There is a larger middle class with more disposable income,” says Ms. Tan, adding that these economies are now supported by local consumer buying goods across all sectors, including entertainment, retail, technology and travel. There is also increasing domestic ownership of stock and bonds.
All this has helped to stabilize these markets. Now, when investors panic, they do not immediately sell out of these stocks.
“When the U.S. economy caught a cold two decades ago, China would catch pneumonia,” Tan says of the largest emerging market economy. “But it’s not that way any more.”
Still solid growth
Emerging markets may be coming into their own, but why should Canadians, who tend to have more of a home bias when it comes to investing, care about companies located half a world away? Because of diversification and growth, says Eric Kirzner, a professor of finance at the University of Torontoʼs Rotman School of Business.
The MSCI Emerging Market Index includes 24 countries and, unlike in previous decades, when all were moving from small export-oriented economies to big economies, each country now has slightly different economic drivers from one another – and, most importantly, more independent of Canada and the U.S. What happens in China, for instance, might not reflect what is happening in Canada, so their stock and bond markets may move differently.
Although most EM countries have experienced significant growth, the gross domestic product (GDP) of many of these countries is still growing at two to three times the pace of more developed economies. According to the International Monetary Fund, India’s economy is expected to grow by 7.4 per cent in 2018, Chinaʼs by 6.5 per cent and Vietnam by 6.6 per cent.
While several emerging market nations have done well over the past two years – the MSCI China and MSCI Brazil indexes are up 57 per cent and 53 per cent, respectively, according to S&P Capital IQ – Ms. Tan still sees attractive opportunities in the EM universe. She remains bullish on India, where two-thirds of its economy comes from domestic consumption. That domestic demand is only ramping up, she says. Her call on the country has so far paid off – the Sun Life Excel India Fund, which holds banks such as ICICI Bank Ltd. and tech companies like Infosys Ltd., was the top performing emerging markets fund in 2017, according to The Globe and Mail.
Prof. Kirzner thinks India will see more growth, too, as will several other nations.
“Any mid to long-term horizon equity portfolio should have economic powerhouses China, South Korea and India and possibly some South America,” he says.
Accessing Emerging markets
Investors can get access to these markets in several ways. They could buy Canadian or U.S. multinationals s that have growing footprints in these nations, or exchange-traded funds (ETFs) that mirror the performance of a particular country or an index based on a broader sampling of emerging market stocks.
Investors can also buy actively managed mutual funds, which Ms. Tan says Canadians should consider doing as it can be difficult for investors to stay on top of the fast-paced changes taking place within these burgeoning economies.
She contends, for example, that while multinationals such as McDonald’s have expanded rapidly over the past decade in China, their future growth does not hold as much promise as many domestically-based, consumer-driven companies, many of whom have the advantage of being more nimble and have the benefit of being singularly focused on the domestic market.
For example, Alibaba Group Holding Ltd., China’s version of Amazon.com, has a much faster growth trajectory than many of its global peers and now ranks among the largest companies in the world, she says.
ETFs can provide exposure to mega cap names such as Alibaba and tech firm, Tencent Holdings Ltd., but investors must grapple with overconcentration risk. For example, an ETF tracking South Korea’s stock exchange might have 20 per cent of its assets in Samsung Electronics Co. Ltd., the largest stock on its index.
Active managers can better control that asset-allocation risk, Ms. Tan says while also helping to smooth out volatility, which is still higher than in developed markets.
In Ms. Tanʼs view, having expertise on the ground in these rapidly growing economies and markets is essential.