Is now a good time to consider boosting your emerging market exposure?
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Portfolio managers from Colonial First State, Vanguard and Aberdeen give their views on emerging markets in the current global economic climate and how exposed individual investors should be.
When deciding whether or not to dip into emerging market funds, timing actually means very little, according to Jeff Johnson, head of investment strategy at index fund manager Vanguard.
"We often get asked when is a good time to invest in emerging markets compared to developed economies. It's a point that we've researched quite a bit, and the answer that we've found is there is essentially zero correlation between long-term stock returns and GDP," Johnson says.
"Some investors will look to get excited about investing in certain emerging markets or countries when it looks like they're growing faster, but our research has found there isn't a relationship between the growth of an economy and stock returns.
"The implication is that ... rotating in and out of the emerging markets is going to be difficult for people to time correctly on an ongoing basis."
Josh Hall, investment specialist, global equities strategies, Aberdeen Asset Management, is less equivocal.
"We think they have significant appeal. If you think about the excessive levels of leverage and very low, if not negative interest rates [in most of the developed economies] it's generally leading to quite anaemic economic growth," Hall says.
"Emerging markets don't have those problems, with more robust levels of economic growth, and more normal economic and financial market conditions."
Peter Dymond, executive manager investments, Colonial First State, also believes current global market conditions may make emerging countries a more appealing proposition right now.
He recently visited with a number of the firm's portfolio managers, around the time the news of the Brexit vote was breaking.
Dymond says he received "a pretty clear message from them that emerging markets were looking increasingly more attractive compared to developed markets".
"A lot of the managers hadn't acted on that view at that point in time, apart from one or two of the more active or forward-thinking, high-conviction managers. Since then we've seen a lot of money effectively flow into emerging markets ... relative to developed markets," Dymond says.
He says that in the last month alone, emerging markets returned 4 per cent in Australian dollar terms versus the global index return of 1.27 per cent.
However, he expresses some concern over this, with so much recent emerging market performance being liquidity-driven.
Dymond also urges investors in Australia to be mindful of the impact of currency differentials, particularly in the way the Australian dollar is correlated with emerging market currencies.
"A lot of the performance that could be occurring in emerging markets doesn't necessarily transfer through to investors here. You've just got to be careful how those numbers reported in the press relate to Australia because of that correlation effect," he says.
Active versus passive
As an index fund manager, Vanguard favours a passive approach, largely because of the greater diversification it offers. Its emerging markets fund has exposure to more than 800 stocks located in 22 emerging economies.
"The real appeal for us, [of] investing in emerging markets, is for diversification purposes. We like emerging markets because they can go through periods where they perform much more differently than developed markets," Johnson says.
Around 60 per cent of Australian self-managed super funds (SMSFs) have more than half of their portfolio held in one investment type, according to a March 2016 study from Investment Trends.
The same research found more than 28 per cent of SMSF trustees have more than half their share portfolio invested in banks or financial stocks.
"What we would caution investors against doing is reducing or eliminating their exposure to emerging markets when they go through a period of underperformance--that has been the case over the last one to three years," Johnson says.
Likewise, investors shouldn't overweight their portfolios toward emerging markets following a period of outperformance.
"We believe investors of all types should be very broadly diversified, but we believe that the most critical decision ... is the strategic asset allocation and the mix of growth or risky assets with more defensive or income-oriented assets."
The benefits of being different
Aberdeen's Hall emphasises the distinctions between emerging and developed markets as among the biggest opportunities such funds offer.
In the current environment, he says: "Emerging markets [have] ... more robust levels of economic growth, and more normal economic and financial market conditions."
"They don't have the excessive leverage and cheap money you've seen in developing markets ... and have young, hard-working populations that are aspiring to a western style of life."
Aberdeen's emerging equities team is particularly bullish on Brazil at present, highlighting it as one of the best-performing emerging markets of the last 12 months.
"We've had several positions in Brazil, and a number of those have been among our better ones over the last six months," he says.
Hall also names India and Indonesia as markets to watch, given they are each on economic growth trajectories yet are "probably about 10 to 15 years behind China, they haven't been through this rapid economic expansion phase that China has been on, but are just starting that process".
However, he also emphasises that emerging market investing is not for everyone.
"It doesn't come without its risks, and can be very dependent on the individual country. Our approach is to have people on the ground, to have an investment style that is biased towards more mature, higher-quality companies," Hall says.
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Glenn Freeman is Morningstar's senior editor.
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