Bryan Collings, manager of the Ignis HEXAM Global Emerging Markets Fund, outlines ten reasons why it is more important than ever for investors to have sufficient exposure to emerging market growth.
He says, ‘The majority of UK and US investors only have approximately five per cent emerging markets exposure within their portfolios despite sound structural drivers and impressive market performance in these developing markets. It makes no sense to have so low an allocation to such a large and important asset class.’
Why emerging markets?
1. Drivers of global growth
Taken together, the emerging markets, including the Middle East, comprise the largest economic bloc, accounting for around 36 per cent of the global economy in terms of gross domestic product (GDP).
According to the International Monetary Fund’s latest estimates, China is the single country that contributes the most to global economic growth, with Russia, Brazil and India also among the top eight contributors. Higher growth tends to lead to higher equity market returns.
2. Favourable demographics
Emerging markets represent approximately 75 per cent of the world’s land mass and house more than 80 per cent of the global population. Most of the future population growth is expected to be in emerging markets, where the population is expected to grow five times as fast as in developed countries. This means emerging markets tend to have a high – and growing – proportion of young, skilled people.
3. A high and growing number of consumers…
By 2030 more than one billion people in emerging markets are forecast to join the ever-increasing consumer middle class. Currently, personal consumption in China accounts for only 37 per cent of GDP, compared with more than 60 per cent and 70 per cent in Europe and the US respectively. There is, therefore, scope for significant further spending.
4. …with money to spend
The world’s savings are concentrated in emerging markets, which hold 75 per cent of the world’s total foreign exchange reserves. Emerging economies are less indebted than their developed peers at the country, company and individual level.
Importantly, banks in emerging market countries have emerged from the recent credit crisis relatively unscathed as they generally had little or no exposure to the ‘toxic assets’ associated with the sub-prime mortgage fallout in the US. This provides strong foundations on which to build future growth.
5. Reduced dependence on developed economies
Emerging markets have a wealth of natural resources, including more than 90 per cent of oil and gas reserves, 70 per cent of coal reserves and 60 per cent of copper, nickel, iron ore and bauxite reserves.
‘South-south trade’ (not involving developed economies) has proved resilient, and emerging markets are fast becoming the largest commodity consumers as the urbanisation process (linking urban and rural populations) continues apace.
6. Equity outperformance
Emerging market equities have outpaced their developed market peers both since the launch of the MSCI Emerging Markets Index in 1987 and over the past ten years, during which they have outperformed by an impressive 166 per cent.
7. Superior profitability
High GDP growth typically translates into higher return on equity (ROE). The profitability of emerging markets companies is superior to that of companies in developed markets.
8. Similar volatility; higher returns
Investment in emerging markets is often viewed as ‘more risky’ than developed markets. Over the past ten years, however, a blended portfolio of emerging markets and developed markets exposure would have demonstrated a similar level of volatility but provided far superior returns.
9. Declining volatility
Volatility within emerging markets has actually been trending lower for years and has consistently remained within a narrower range than both the FTSE All Share and S&P 500 indices. During the recent crisis, emerging markets’ volatility peaked at a lower level than that of developed markets, and subsequently dissipated more quickly.
10. Market capitalisation
Despite their dominance in terms of world population, land mass, foreign exchange reserves and GDP growth, emerging markets have just ten per cent of world equity market capitalisation. This has been growing over the past decade, and with it equity market returns have risen. This trend is likely to gather pace over the coming years.